Many people have asked me what to do in this market environment, and I have sat and thought about it. My own personal portfolio is around 60% equities, 15% my home, and 25% cash.
I think probabilistically. I don’t focus on just one scenario. I try to balance across a wide number of scenarios, and ask what will do the best. In a foggy situation like today, that answer is not easy.
I will give you an example. 8.5 years ago, the leaders of my church came to me and said “Would you invest the money for our congregation’s building fund?” My initial answer was “no.” I don’t like investing money for friends, generally. They came back again, and said, “Please?” I felt ashamed, and said, “Okay, fill out this risk questionnaire.” They gave me a series of answers that essentially said, “We don’t know when we need the money, but get a good return for us.”
Ugh. In May of 2000 went back to Ben Graham’s 50/50 (stocks/bonds), and then adjusted it, taking 10% from the area of the market that I liked worst, and added it to the area I liked best. I took growth stocks and sold them and bought long term corporate bonds.
Since then I have made further adjustments. The current portfolio is:
- 5% Energy stocks (VGENX)
- 5% Gold stocks (VGPMX)
- 25% International stocks (VINEX)
- 25% TIPS (VIPSX)
- 20% Intermediate Investment Grade Corporates (VFICX)
- 20% High Yield (VWEHX)
Much as I like Vanguard, I am not endorsing any of their funds here; they are example for asset allocation. I am very light on US stocks here, and intentionally so. This portfolio has an anti-inflation bias, and will do better against a weaker dollar. The corporate bonds, both investment grade and high yield, replace equity exposure. Corporates are cheap relative to common stocks, and they have better protective characteristics as well. Though I don’t have any closed-end corporate floating rate funds here, they could be interesting if their leverage was low enough, which isn’t common. As for the international developed market stocks, a basket of different countries will likely do better than a simple US exposure, even if the dollar continues to fall.
TIPS have been a fatal attraction for me, and I hope to have a post out in the near term explaining their value in this environment where inflation is negative for now. My view is that the Fed will eventually monetize the debts they are incurring. Also, as the dollar gets weaker, inflation will get imported back into the US.
What could go wrong here? We could have a trade war, or the US government could take actions to protect the value of debt held by foreigners (not likely). If the equity markets rally, investment grade corporates and high yield will not be far behind, but this portfolio would lag.
No portfolio is perfect. This one certainly isn’t, but it is my attempt to position for what I view as a lousy economic environment that will eventually yield inflation.
Full disclosure: long VIPSX, and my church long what is listed above
How has the “Church Portfolio” performed since inception?
David,
A comment and a question.
I second your inclusion of your home in your personal portfolio. This works generally, but I think it works especially now. Any investor with a dedicated allocation to treasuries might find paying down their mortgage a superior “bond” strategy.
My question concerns the mention of a risk tolerance survey. Do you find these reliable? I see the trouble you had applying it to a group of folks with collective funds. I also find these surveys unreliable for individuals.
Thanks
I think you are too heavily invested in high yield bonds. You would be better served to just buy equities via the Total Stock Market Index Fund instead of substituting in High Yield Corporates to gain equity exposure. High Yield Bonds do not have the upside potential, but they have most of the downside risk.
Once the credit markets improve, stocks will rise, but your high yield bonds will be called away at par. The call provision most high yield bonds have severely limit your upside and make high yield bonds a bad choice if you are looking for a “hybrid” type equity/bond allocation. You would do better just by purchasing equities directly, and then buying short term high quality bonds. That gives you both equity and bond exposure, but with a better risk/reward profile.
P.S., I like TIPS because they guarantee a positive real return and are a good hedge against inflation. Especially unexpected inflation. Real yields were recently above 3%, a great buying opportunity in my opinion.
Interesting, what is you rebalance stragety for 2009 if you have thought about it.
What to do ?
Do NOT buy DFR !!!!!!!!!!!!!!!!!!
I like the diversification that you have although holding 25% international seems like too much at this time when the US is ahead of the rate cuts compared to everyone else.
Stock Swing Trades: Rate cut/equity price correlation is pretty weak – there are more important things to think about. Notice how short-lived the various rate cut bounces in equities have been.
BJ Feng: I’m pretty sure David knows more than you about bonds. Under general circumstances and in the long term equities perform better than all types of bonds. We’re not in general circumstances and we don’t know how long one will have to wait to see renewed dividend raises from many companies. Think about a company like GE that is able to scrape along and presents minimal true credit risk, but won’t be increasing EPS or dividends any time soon and can’t afford to do buybacks now that the stock price finally justifies it. Low-priced debt may be a better buy for the next 10 years than volatile equity. People have recognized this trade in GE (stock price still down while debt prices rebound), but in higher-yield companies there might still be some edge to exploit. Of course that’s trading sentiment.
In general terms, although HY does share some problems with bonds AND stocks, there’s no asset class that’s permanently useless. A time when everyone hates high-yield, such as our recent history (in which stocks have been hugely volatile, including to the upside in most people’s memory, and legitimate high-rated bonds have held up pretty well through some equity downturns), is the time to allocate to high-yield. A time when everyone loves high-yield and agrees that it presents the best of both worlds is the time to get out. Overall it’s going to fill the hybrid role decently on a long time horizon.
I think the last thing anyone is worried about right now is their high-yield bonds being called at par. There are plenty of people who would jump at the chance to sell some holdings at fifty cents on the dollar.
Would it be possible to see your risk questionnaire? I am curious to see what it entails and what my answers reveal.