Monday, November 9, 2015

Is the Present the New Normal?

The traditional rule of thumb was your age in bonds. If you were 60 years old you should hold 60% of your investment portfolio in bonds and 40% in stocks. The new conventional wisdom states that given the risk of inflation, you need about 15% more in stocks than suggested by the old rule of thumb. Hence, at age 60 you would hold 45% in bonds and 65% in stocks. I haven’t checked recently, but I am somewhere around a 50/50 split at age 64. I tend to buy into the argument that it is wise to be a little too conservative in the first years of retirement, as it would be very difficult to recover from a major market crash while maintaining a 4% draw.

Scott Puritz, managing director of Rebalance IRA, believes that such traditional models of asset allocation are hopelessly outdated. Instead, he recommends:

100% in stocks during your 20s and 30s
90% to 100% during your 40s
75% to 85% during your 50s
70% to 80% during your 60s
40% to 60% during your 70s

His logic is based on the historic low interest rates offered by bonds. Ten year Treasuries pay a pitiful 2.15%, while AT&T stock current pays 5.74%. In his mind, shares in AT&T should be considered as part of your bond portfolio. Bond funds, CDs, and the like are paying just about nothing these days, but the market has been artificially inflated by the policies of the Federal Reserve Bank. Right now the Shiller price earning index is at 26.22, a dangerous number. Is this really a good time to put 75% of my liquid net worth into overpriced equities? I see a whole lot of downside risk and not as much upside potential. How much more can the Fed do without the risk of inflation?

For the record, I am a huge fan of stocks that pay a good sustainable dividend. In fact, if it doesn’t pay a dividend, I am not sure why I would want to own it. Of course, there are stocks that don’t pay dividends represented in my mutual funds and I do own some gold. Studies indicate that about 50% of the increase in your portfolio over time will be generated by dividends.

Puritz also recommends investing more in foreign equities. I agree. I would guess that I am running somewhere around 15% in foreign equities, maybe a bit more. Today the U.S. still controls about 50% of the world’s wealth, but the rest of the world is headed up and we are headed down. I should probably consider bumping that number up closer to 25% or even 30%. U.S. markets are way safer than those of the developing world (Brazil, Russia, India, and China) but the markets of Europe and Canada are pretty similar to our markets. Japan is worrisome. Their deficit is screaming danger. If that nation wasn’t so incredibly productive, I believe their economy and the value of the Yen would have already crashed.

I think that even in your twenties you should hold a small percentage in bonds and such. When the market tanks, and it will, the young investor would then be in a position to convert his holdings in bonds into a once in a generation opportunity to load up on high quality stocks at a very low price.

It is said that J.P. Morgan had a friend who told him he was so worried about his stock portfolio that he couldn’t sleep. The distraught investor asked the great master for advice. Morgan replied, “Sell down to your sleeping point.”

Puritz puts a different spin on this advice.

“There’s no sense in creating the optimal asset allocation that works at an intellectual level if when the markets drop, the investor can’t sleep at night,” Puritz says. “Particularly, as people get older, have families and mortgages and are paying down debt, their financial situations get more complex, so it’s good to have a seasoned professional in the mix to strike the right balance for you personally.” (USA Today: The 60/40 stock-and-bond portfolio mix is dead in 2016)

Even a seasoned professional can’t see into the future. Remember. If the market loses 50% of its value, you will need to double your money to get back to even. Even if the market rebounds from such a crash at 12% a year, it is going to take several years to get back to your starting point. However, if you have maybe a little more than you should in your bond portfolio, you will be able to buy shares at a time when a blind monkey throwing darts could put together a winning portfolio. It’s a bad time to buy stocks. It’s a bad time to buy bonds. It’s probably not a good time to buy real estate, but real estate is not my game. Please—Let’s be careful out there.

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