Last week I was invited on NetWorth Radio to discuss the municipal bond market (link to interview here). Afterwards, I thought of the dilemma most investors must be in when it comes to deciding on what asset classes they should hold in portfolios. This is an interesting topic of discussion and worth the time to visit at least two points of contention investors may run across.
Point of Contention #1: Can I use a traditional mix of 60% stocks/40% bonds to make money in this market?
The short answer is probably not. Why you can’t is an in-depth discussion but revolves around relatively slow global growth and divergent monetary policies (just Google “divergent monetary policy” to see what I’m talking about). Historically, investors could associate expected return with the amount of risk being assumed with an investment. The risk being assumed is referred to as a risk premium. The risk premium is the amount of return over the risk free rate you expect to be compensated. The risk-free rate has always been assumed to be positive, but in certain economies it is now negative. This does two things mainly: it lowers the amount of expected return of most asset classes since the risk free rate is now negative and it forces an investor into riskier asset classes to avoid negative returns. So, using traditional investment methods may not achieve investment goals. This may lead to the next obvious (or not so obvious) conclusion: Does this flight into riskier asset classes foreshadow the collapse of the market for risky asset classes? Possibly. What usually happens when everyone piles into a good idea…
Point of Contention #2: What are the implications of using a non-traditional asset mix to achieve my investment goals?
One implication, which is probably the hardest to hear, is that investors will need more financial capital. Investors should be prepared to work longer and delay retirement. This does two things to improve their situation: it produces more actual dollars to retire on, and it shortens the length of time in retirement. Traditionally, stocks have averaged between 7-10% annually (I’m using both high-tide and low-tide averages), but this has lately not been the case and will not be the case in the future. Consider that most pension plans are underfunded because of their utilization of traditional investment strategies to produce 8+% returns for future liability payments to plan participants. If pension plan managers have struggled to achieve returns for the millions and billions they invest, why would it be any different for individual investors? The answer is that it isn’t. That said, individual investors have the advantage of using non-traditional asset mixes to achieve their goals. Portfolio construction with non-traditional asset classes can be a refreshing drink of water to parched portfolios.
Point of Contention #3: Ok. You’ve got me thinking, what should I do?
Consider getting the perspective of an investment professional for your investment goals. I’m happy to say that day in and day out, I gladly assist investors in navigating what can be a very confusing and intimidating investment landscape. Consider that the Department of Labor just issued rules on how investment professionals should interact with investors’ retirement assets, so you may realize a change in how you receive investment advice. I won’t go into the rule in this writing, but the implications for the investor could be higher costs as firms adjust to comply with the rule. These firms will be those that have not been operating at the fiduciary standard all along. Natural to this process may be shifts in and out of asset classes (e.g. fund flows) that will affect future investment returns. With literally thousands of retirement plan participants and trillions of dollars at stake, investors should be prepared to hire an investment professional to help co-pilot what could be a bumpy ride.