I’m often asked where I think the economy or market is headed. Readers of my CNN Money interview, or my recent article on overcoming the fear of stocks, might think I’m especially bullish on stocks. But that’s not the case. I’m bullish on diversification.
I like bonds too. As I write this, my allocation to bonds and cash is about 53% of my portfolio. I’ve written that the performance of bonds in my portfolio was an essential factor in being able to retire early. I don’t see my bond/cash allocation going much below 50%, ever. My comments in the two articles linked above were aimed at those who are under-allocated to stocks, in the belief they are playing it safe.
Many think that being safe means holding all cash. Well, there is very little that I’m sure about these days, but one of the things I’m least unsure about is this: If you keep most of your assets in cash, you will almost surely not make it through a 30+ year retirement without running out! Unless you have multiple millions, or live like a college student, cash simply won’t produce the returns needed for your nest egg to survive. If you have any doubts about that, just look at the current microscopic returns on bank savings accounts. And, if we get another bout of nasty inflation, as so many insist is inevitable, the damage to your cash stash will be even worse.
No, I don’t have a window on the future, and I have no idea where the economy or stock market will go tomorrow. Things will either be better, or worse, or possibly about the same.…
For example, here are some reasons to buy stocks right now:
- Signs of a modest economic recovery are everywhere.
- Stocks have grown little in the past 10 years; it’s their time.
- The Fed continues to support asset prices, plus it’s an election year.
And here are some reasons to avoid stocks:
- Signs of a false or artificially-stimulated economic recovery are everywhere.
- Price/earnings ratios are near historic highs.
- An entire generation has been burned by stocks, again.
Here are some reasons to buy bonds:
- The Fed continues to hold yields down, and thus support bond prices.
- Bonds, especially U.S. Treasuries, will continue to be a safe haven for those worried about Europe and the world economy.
- If we enter another economic slowdown, high-quality bonds and their income will be appealing.
And some reasons to avoid bonds:
- The Fed continues to artificially support bond prices.
- Yields are at historical lows: they can only go up, meaning bond prices can only come down.
- Bonds will suffer and underperform if the high inflation that everyone is predicting arrives.
Get the picture? Neither do I.
Which brings me to the most important point of all: Don’t try to predict the future, but do try to understand your possible reaction to it. Use that knowledge to pick an appropriate asset allocation. Implement that allocation in your portfolio. Rebalance if it gets way out of whack. Then ride out whatever storms ensue, and enjoy the good weather in between!
There are numerous tools and approaches available, from the simple to the sophisticated, to find the optimal asset allocation based on your risk tolerance and time horizon. I list some of them in my article on Diversification thru Allocation.
If you’re in doubt, let me expand on a very simple idea: What is the age-old compromise when there is an undecidable argument between two positions? “Split the difference.” If you read all the predictions for the future and are paralyzed by indecision (and who could be blamed for that), then start with a 50/50 allocation. That has the intuitive appeal of sharing the risk among two common, and uncorrelated, asset classes. If you can make a more sophisticated analysis, great. But do something to diversify, if you aren’t already.
You might be encouraged to know that many of the safe withdrawal rate studies show that your asset allocation, within broad ranges, has little impact on your ability to withdraw from your portfolio in retirement.
Whatever you do, don’t make a panicky or fear-driven bet on a single asset class — whether that be stocks, bonds, gold, cash or something else.…
Because, when I gaze into my crystal ball, here are my top investment picks going forward:
- Diversification will continue to outperform all but a few lucky “bet the farm” strategies — which will remain unknowable until after the fact.
- Lower expenses will continue to outperform higher fund expenses and, amazingly, will even foretell the performance of your investments.
- Passive index investing will continue to track the market’s performance, and beat active investing.
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