Source: International Jugglers’ Association
For months—years—I’ve been extolling the virtues of portfolios that are primarily comprised of bonds. Especially in retirement.
Bonds provide necessary diversification. They may end up reducing returns, but you are more than compensated by the reduction in risk.
A few months ago, people were giving me a lot of grief about this. I heard all about how irresponsible it was to promote bonds in a low interest rate environment. Then interest rates went even lower, as stocks went down a lot.
So people with a bond-heavy portfolio would have been… happy. Or at least, they would have slept well at night.
Never mind the fact that because of convexity effects, when interest rates are low and go even lower, bond prices go up a lot. When the Fed cut rates 50 basis points in early March, at one point the long bond was up more than five points in a day.
And people say that bonds are boring!
Anyway, the point of holding bonds is for the diversification benefits. But when interest rates are very low (close to zero), some of those benefits start to disappear.
This makes things very hard. If stocks are volatile, and bonds are no help, where do you put your money to mitigate volatility? There aren’t many options.
Here are your options:
- Commodities (especially gold)
- Real estate (either physical real estate or REITs)
- Misc., like collectibles and art
Generally, art and collectibles do a pretty poor job of diversifying a portfolio. They’re cyclical and tend to move with stocks.
I always like cash, and everyone should have 10–20% cash in their portfolio at all times. The good thing about cash now is that, with interest rates at such low levels—perhaps even negative—the opportunity cost of holding cash is low.
It’s kind of dumb to hold cash when interest rates are 8%. Makes more sense when rates are at 1%.
The big diversifiers are really commodities and real estate. Commodities are a tough sell right now, though. They have a negative cost of carry, and they’ve been going down for a long time.
We’re currently experiencing a deflationary shock with coronavirus, but my suspicion is that the deflation is a head fake.
Within commodities, though, gold has a special role. Its whole purpose is to provide diversification, because it’s the anti-stock and anti-bond. It’s the alternative to traditional finance. And the correlation is typically zero, or negative (or it used to be).
I think that it makes sense to move away from bonds as a diversifier and toward gold.
That’s hard for people to swallow. I proposed this to my mom who thinks gold is risky. It is certainly “riskier” than the bonds she is holding, if you define risk as volatility. But again, you add something with low correlation to stocks and bonds to the portfolio, and it is going to improve the risk characteristics.
The same is true for real estate, although less so. The nice thing about real estate is that it also provides income, which gold doesn’t. Although again—in a low rate environment, the opportunity cost of holding gold is practically nonexistent.
Real estate should perform well in an inflationary environment, and it should also provide decent diversification benefits.
People have very practical concerns about how to 1) save for retirement and 2) protect against inflation in a low interest rate environment.
To do that, you want a portfolio with less stocks, less bonds, some cash, some gold, and some real estate. What does that look like?
The 20/20/20/20/20 portfolio.
- 20% stocks
- 20% bonds
- 20% cash
- 20% gold
- 20% real estate
This is the benchmark we should be using for the next 10 years and beyond.
Equities Contributor: Jared Dillian
Source: Equities News