Is the Proper Investment Asset Allocation Rule Outdated?

The standard rule – of a portfolio ratio of 60 percent stocks and 40 percent bonds – undoubtedly served investors well for a long time. The once golden rule was based on the concept that stocks carry the likelihood of substantial medium- to long-term gains whereas bonds provide a safety net of reliable, if lower, returns. However, for the last 20 years or so, ever since the dot-com boom of the late 90s, the investment world has realized that traditional advice is no longer fit for purpose. At a time when stocks are soaring and bonds are returning minimal values, investors understandably doubt the wisdom of a 40% bond holding.[1]

The time has come for a different approach; stocks are currently performing extremely well but bonds are showing returns so low as to be barely significant. Portfolio managers can, and do, change the 60/40 weighting as appropriate to reflect current market conditions. Historically low interest rates make bonds a less popular option while the very real threat of inflation means that the dollar value of bonds in real terms will be less in future years than it is today. Options are to adjust the weighting to compensate and/or diversify to provide more profitable returns[2]. Financial advisors also need to look at risk assessments for their clients; for younger clients, in particular, a 70/30 split is likely more appropriate, whereas clients nearing retirement might be better served by a more conservative approach.

Diversification is key to balancing a portfolio; the old saying, “Don’t put all your eggs in one basket” still holds good. By diversifying a portfolio over a range of assets, risk is minimized and volatility lowered. Alternative assets have been growing in popularity in recent years and many investors will allocate up to 20 percent – or more – of their portfolio to alternatives. With the growing threat of inflation, certain alternatives such as real estate, commodities, and private equity and debt offer a very useful hedge.

Real Estate

Historically, real estate outperforms the stock market over time. On the other hand, it is – by its very nature – illiquid and not, necessarily, a profitable short-term investment. The market tends to be cyclical – buying at a high point in the cycle and later needing to sell quickly is not likely to result in optimal returns. That said, the market is enjoying a tremendous boom period at present, both in residential and commercial real estate. Some sectors are particularly attractive: rental units designed for low- to middle-income earners; medical offices; laboratories; self-storage units; and warehousing, to name a few.

Additionally, there are many ways of investing in real estate without necessarily committing hundreds of thousands of dollars. REITs, and mutual funds make the real estate market accessible to those with smaller portfolios. Investing in a real estate fund offers the opportunity to earn money from rental payments and also profit from sales without the emotional commitment or large down payment required to purchase real estate on one’s own. Real estate is no longer the prerogative of institutional or high-net-worth investors.

Commodities

Precious metals, particularly gold, have long been sought after as an inflation hedge. While not earning interest or paying rent, gold bars can quietly increase in value over time. The market is not without some volatility – over the last 10 years, gold prices have veered from a high of $1,800 in September 2011, through a low of $1,070 in December 2015, recently regaining highs of over $2,000[3]. Nonetheless, gold may be the preferred ‘safe bet’ for many investors, especially when facing a period of inflation.

Natural resources such as lumber, minerals, and oil and gas are essential to manufacturing, building, and public infrastructure. We would likely all prefer to see green alternatives to fossil fuels but oil will continue to be necessary for the foreseeable future – if not for heating and transportation, then as a raw material for the petrochemical industry. There are multiple options for investors including mutual funds and ETFs as well as the outright purchase of stocks. Commodities also, of course, include collectibles such as art and wine that are expected to appreciate over time. However, these commodities may have lower levels of liquidity, and many collectors purchase such items due to a private passion, keeping them for their own use and enjoyment – for such investors, profit is a secondary consideration.

Private equity and debt

Private equity involves investing in private companies, sometimes with the aim of turning a struggling company around. These companies are not publicly traded or listed on stock exchanges. 

Private mortgage lending can produce very high returns; some lenders charge up to 20% interest, with an average of around 10%. Individual investors can access this lucrative, if relatively narrow, investment niche market by investing smaller amounts of capital in companies that provide private mortgage funds to commercial property developers, or individual home purchasers. Titan Funding offers investors the opportunity to share in the profits from a variety of private mortgage products: commercial loans, bridge loans, and residential loans; due diligence on the part of fund managers will assure that risks are minimized and returns maximized. 

While the outlook for bonds continues to impact portfolios, it is incumbent up on investors to re-examine the 60/40 rule and diversify while minimizing potential risk. Commercial and residential real estate, some commodities, and the private credit market all offer good alternatives at this time.

[1] Forbes – Kate Stalter, March 13, 2021 https://www.forbes.com/sites/katestalter/2021/03/13/time-to-rethink-the-classic-6040-portfolio/?sh=5a72d102449b

[2] Investopedia – Mark P Cussen, August 12, 2020 https://www.investopedia.com/articles/financial-advisors/011916/why-6040-portfolio-no-longer-good-enough.asp

[3] https://www.gold.org/goldhub/data/gold-prices?gclid=Cj0KCQjwh_eFBhDZARIsALHjIKfX0CrRgPT8M_n557EizfKBCAE_iDD7SOR5T1BRdQWd3yOPhVwAF2YaAm-dEALw_wcB