Asset Allocation For H2 2018: Stocks And Cash Equivalents

  • Passive asset allocation strategies are straightforward and better than no strategy, but cannot be expected to yield first-class results.

  • Through fact-based assessments of the investment environment and common sense, active asset allocation improves prospective returns while reducing risks.

  • We assess risks and rewards for each asset class -equities, bonds, cash equivalents, as of mid 2018.

  • We argue for allocation to equities and cash equivalents, avoiding bonds of intermediate and long-term maturity altogether.

Buying and holding wonderful businesses at compelling prices is one part of producing satisfactory financial results. And at Investment Works, we are giving you unprecedented transparency into the inner works of one of the most successful equity portfolios of the 2010s.

Asset allocation is the other part.

With proper execution, the combination of stock picking alpha and intelligent asset allocation maximizes prospective returns at the level of risk that the investor is willing to bear.

Individual investors are often led to passive asset allocation strategies such as:

  • The 60/40 rule: 60% stocks, 40% bonds.

  • The 100 minus your age rule: (100-age)% stocks, the rest bonds.

  • The All Seasons Portfolio (suggested by Ray Dalio): 30% stocks, 40% long-term bonds, 15% intermediate bonds, 7.5% gold, and 7.5% commodities.

A balanced, passive asset allocation strategy is better, much better, than no strategy.

Just as buying and holding a passive index fund is much better than jumping in and out the wrong stocks at exactly the wrong time.

That's why a static policy of asset allocation to low-fee index funds is appropriate for most savers, who will be, and should be, content with getting average returns from their participation in the US economy.

But if you are reading these lines, chances are that you are willing to put the time and effort and seek the resources, to do better than average. Both in terms of returns and downside exposure.

Consistently beating the stock market is not easy. It takes informed, second-level, independent thinking, courage and discipline.

But the good news is that, when it comes to asset allocation, basic good old common sense can be enough to improve prospective returns and reduce risk relative to static rule-of-thumb recipes.

What we said in January

About six months ago, we warned about the risks of long-term bonds and recommended allocating funds to stocks and cash equivalents, avoiding longer-maturity debt instruments altogether.

Since then, stocks have returned some 4% (dividends included), 30-Year Bonds have lost 3.5% of their value (after half year of coupon payment accrual), and cash equivalents have yielded some 1.5%.

A 50% stock/50% cash portfolio would have returned 2.75%, compared to a meager 0.25% for a riskier 50% stock/50% bond portfolio.

Why did we recommend staying away from bonds? How did we see it coming?

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Disclosure: I/we have long exposure to US equities through the stocks in the IW Portfolio.

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Investment Works 3 years ago Author's comment

Thanks for reading.

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