I have written about this before, but we all know that the only reason anybody would ever read my previous columns would be if I were accused of a triple homicide and the bodies were buried with my old blogs. However, given how reluctant I am to put new money to work at these levels in just about every asset class, I thought it might be timely to revisit the importance of asset allocation.
How much of your money should be in stocks? Or bonds? Or crypto or commodities or real estate or whatever? …Lord knows we’ve been getting lots of questions about it lately.
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As a matter of full disclosure, I just want to confess up front-- to totally own the fact—that my shop’s approach to asset allocation is unconventional. We eschew the traditional 60/40 mix of stocks to bonds, but it’s more than that. At the risk of totally oversimplifying the matter, we advise clients “to invest long-term money long-term and to invest short-term money short-term.”
How do we do that? Much of our asset allocation methodology is based on empirical evidence and our mentality as mean reversionists. The chart below shows that there have only been four ten-year periods ever when the stock market has had a negative return, and all four included either the Great Depression or the 2008 financial crisis.
Therefore, we typically advise that money that an investor doesn’t need for at least ten years should pretty much all be in equities. For shorter term investment horizons, we typically plan that money an investor needs in five years should be in a bond that matures in five years, that money an investor needs in three years should be in a bond that matures in three years, and so on and so on.
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Four times in more than 120 years of publicly traded companies— not bad. Stocks averaged 11.8% a year annualized return while bonds returned less than half of that. And over any 10-year period, stocks did better than bonds 89% of the time.
The fact is that bonds are subject to inflation risk. Since bond interest payments are fixed, their value can be eroded by inflation. The return during the worst 10-year period for bonds was 10 percent lower than the worst 10-year period for stocks. The chance of incurring real money-- inflation-adjusted-- losses over any 10-year period was seven times greater for bonds than it was for stocks. And while it’s significant that stocks did better than bonds 89% of the time over ten year periods, the case for equites becomes even more compelling over 15-year periods, as stocks beat bonds every time and never failed to beat inflation.
On the other hand, bonds would have generated negative real money returns for every single decade from the 1930’s all the way though the 1970’s.
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So, we maintain a pretty simple view on asset allocation. Invest your long-term money long term, and invest your short-term money short term. The empirical evidence suggests that any money you don’t need for at least ten years should all be in stocks.
For investors who have capital that is specifically designated for fixed income and short-term liquidity needs, we still encourage putting that money to work. Municipal bonds are relatively scarce, and the technical backdrop for the municipal market has solid long-term underpinnings. The size and supply of municipals have remained relatively steady while Treasury and corporate debt markets have experienced dramatic expansions. Municipals have not been immune to the rising interest rate environment, but they’ve been able to largely escape the sharp rise in global yields due to that robust technical environment and the passage of the $1.9 trillion American Rescue Plan, which clearly benefitted many municipal sectors.
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Yes, the unknowns bear close watch and are likely to generate short-term volatility, but we can expect better visibility in the coming months on several key concerns such as vaccination rates, taxes, and job creation. Investors, in our view, should therefore prepare for emergent risks even as they seek to capitalize on opportunity.
Therefore, we emphasize:
Value-oriented cyclical stocks, especially in financials and energy.
Complementing high quality municipal bonds with private credit for potentially attractive yield premiums and diversification benefits.
Investing sustainably through environmentally, socially, and economically aware strategies.
For disclosure information please visit: https://www.rgbarinvestmentgroup.com/terms-and-conditions.
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