Diversify. Rebalance. Invest globally.

  • January 28, 2016

Mike JonesInvestment Insights

MIKE JONES

 

Global asset classes in the twentieth century produced nice gains in wealth for individuals who bought and held those assets for long periods of time. It is also true that these assets went through long periods of stale performance or regular and painful drawdowns, like the Global Financial Crisis of 2008.

I would like to share with you several insights about investing in the US from 1900-2014 from a book I recently read, Global Asset Allocation by Mebane Faber.

CASH Leaving cash under your mattress is a slow bleed for a portfolio. Inflation is a major drag on returns. When it gets out of control, it can completely wipe out your cash and bond savings. So you mattress stuffers – on average you would have lost about 4% a year 1900-2014 by keeping your money at home.

T-BILLS Next up are real returns for short-term government bills. These instruments do all they can just to keep up with inflation. You’re not usually going to make any money, but at least they don’t lose 4% a year like the mattress does.

10 YEAR US TREASURIES Adding a little duration risk doubles the historical returns of bills for our 10-year bonds, but that is still a pretty small return. You’re not going to get rich with 1.7% real returns, and you still have to sit through a 50% drawdown, if history repeats itself.

US STOCKS And finally, we have the real returns for stocks. Much better! Over 4% real returns per year is far superior to returns of the bond market. While these are great returns, realize that it would still take over 15 years to double your money!

One would think that the math above would make the decision easy – just put all your money in stocks! While stocks outperformed the returns of bonds and bills, stocks are not without their own risks. At least two countries had their equity markets wiped out when the government shut down the capital markets. Other countries experienced large drawdowns, and even in the United States, an investor lost about 80% from the peak in the 1929-1930s stock bear market. The unfortunate mathematics of a 75% decline requires an investor to realize a 300% gain just to get back to even.

Using current valuation measures investors are presented with the following opportunity set of annual returns for the next ten years (assuming 2.25% inflation going forward, rounding to make it simple):

U.S. Stocks: 3.50% nominal, ~1% real
U.S. Bonds: 2.25% nominal, ~0% real
Cash/T-bills: 0.00% nominal, -2% real

That leaves a 60/40 investor with a 2-3% nominal return no matter which way you slice it, or about a 0-1% real return. Not exactly breathtaking! Many investors expect 8% (or even 10% returns) per year.

Source: Global Asset Allocation by Mebane Faber.

With these bleak forecasts what is an investor to do?

We believe that expanding the traditional US stock bond allocation into a more diversified and global allocation is the key. The following chart illustrates the largest global investable assets.

mike article graph

There is no reason, however, for investors to focus exclusively on stocks and bonds.

Over the last 15 years an entirely new class of investments has been engineered. It has been termed “alternatives.” Investments in this realm seek to be an alternative to traditional stock and bond investing. The goal: make positive returns with little correlation to the traditional portfolio structure.

In addition to alternative investments, one can also further diversify by adding real assets like real estate, commodities or gold.

Diversify. Rebalance. Invest globally. These will be the themes Argent Advisors will be pursuing in 2016.