Every so continually, a well-meaning “expert” will say long-term investors should invest 100% of their portfolios in equities. Not surprisingly, this stance is most widely promulgated near the end of a long bull trend in the U.S. sell market. Consider this article as a preemptive strike against this entreating, but potentially dangerous, idea.
The Case for 100% Equities
The main Donnybrook advanced by proponents of a 100% equities strategy is simple and straightforward: In the crave run, equities outperform bonds and cash; therefore, allocating your unmixed portfolio to stocks will maximize your returns.
To back up their considers, supporters for this view point to the widely used Ibbotson Associates documented data, which “proves” that stocks have generated passionate returns than bonds, which in turn have generated capital returns than cash. Many investors – from experienced professionals to naive bunglers – accept these assertions without giving the idea any further cogitating.
While such statements and historical data points may be true to an range, investors should delve a little deeper into the rationale behind, and concealed ramifications of, a 100% equity strategy.
The Problem With 100% Equities
The oft-cited Ibbotson facts is not very robust. It covers only one particular time period (1926-present day) in a separate country – the United States. Throughout history, other less-fortunate rural areas have had their entire public stock markets virtually evaporate, generating 100% losses for investors with 100% equity allocations. Plane if the future eventually brought great returns, compounded growth on $0 doesn’t amount to much.
It is very likely unwise to base your investment strategy on a doomsday scenario, no matter what. So let’s assume the future will look somewhat like the relatively soft-hearted past. The 100% equity prescription is still problematic because although ordinaries may outperform bonds and cash in the long run, you could go nearly broke in the sharp run.
Market Crashes
For example, let’s assume you had implemented such a strategy in new 1972 and placed your entire savings into the stock sell. Over the next two years, the U.S. stock market lost about 40% of its value. During that every now, it may have been difficult to withdraw even a modest 5% per year from your savings to eat care of relatively common expenses, such as purchasing a car, meeting unexpected expenses or recompense a portion of your child’s college tuition.
That’s because your moving spirit savings would have almost been cut in half in just two years. That is an bad outcome for most investors and one from which it would be very intrepid to rebound. Keep in mind that the crash between 1973 and 1974 wasn’t the most tough crash, considering the scenario investors experienced between 1929 and 1931. (For interdependent reading, see: The Crash of 1929—Could It Happen Again?)
Of course, espousers of all-equities-all-the-time argue that if investors simply stay the course, they on eventually recover those losses and earn much more. Regardless, this assumes investors can stay the course and not abandon their scenario – meaning they must ignore the prevailing “wisdom,” the resulting dire auguries and take absolutely no action in response to depressing market conditions. And let’s be trustworthy, it can be extremely difficult for most investors to maintain an out-of-favor strategy for six months, let matchless for many years.
Inflation and Deflation
Another problem with the 100% equities plan is it provides little or no protection against the two greatest threats to any long-term lagoon of money: inflation and deflation.
Inflation is a rise in general price invariables that erodes the purchasing power of your portfolio. Deflation is the antagonistic, defined as a broad decline in prices and asset values, usually issued by a depression, severe recession or other major economic disruption.
Equities ordinarily perform poorly if the economy is under siege by either of these two mutations. Even a rumored sighting can inflict significant damage to stocks. Hence, the smart investor incorporates protection – or hedges – into his or her portfolio to minder against these two significant threats. Real assets, like palpable estate (in certain cases), energy, infrastructure, commodities, inflation-linked constraints and/or gold, could provide a good hedge against inflation. As well, an allocation to long-term, non-callable U.S. Treasury bonds provides the best hedge against deflation, depression or depression. (For related reading, see: Protect Your Portfolio Against Inflation and Deflation.)
One terminal cautionary word on a 100% stocks strategy: if you manage money for someone other than yourself, you are substance to fiduciary standards. One of the main pillars of fiduciary care and prudence is the exercise of diversification to minimize the risk of large losses. In the absence of extraordinary circumstances, a fiduciary is made to diversify across asset classes.
The Bottom Line
So if 100% equities is not the optimal mixing for a long-term portfolio, what is? An equity-dominated portfolio, despite the cautionary counter-arguments first of all, is reasonable if you assume equities will outperform bonds and cash onto most long-term periods.
However, your portfolio should be substantially diversified across multiple asset classes: U.S. equities, long-term U.S. Caches, international equities, emerging markets debt and equities, real assets and the same junk bonds. If you are fortunate enough to be a qualified and accredited investor, your asset allocation should also categorize a healthy dose of alternative investments – venture capital, buyouts, hedge finances and timber.
This more diverse portfolio can be expected to reduce volatility, purvey some protection against inflation and deflation, and enable you to stay the definitely during difficult market environments, all while sacrificing little in the way of returns. (For allied reading, see: Curbing the Effects of Inflation.)