2015 has me wondering – is this a precursor to what the future could look like? That is, are the low returns across so many asset classes likely to be a sign of what’s to come? In a BNN interview from this morning I laid out the case for why returns are likely to be lower and how we can be proactive about it.
Here’s the gist of my thinking:
- We know that the Global Financial Asset Portfolio is roughly a 45/55 stock/bond portfolio today.
- We also know that bonds likely won’t generate high returns in the future given the low interest rate environment (current rates are a very reliable indicator of future returns).
- We also know that stocks are overvalued by many metrics and very likely more risky than they were in 2009/10/11.
- So, let’s be generous on the stock side and assume 10% returns and 3% from bonds (also generous given the aggregate yield of about 2.5%. That gets us to about 6.5%. But what’s scary about the 6.5% is that it will be driven mainly by the inherently more risky piece of the portfolio – the stocks.
- So, returns are likely to be lower and/or riskier than we’re used to.
Given this high probability outcome I think the markets have forced us to get creative to some degree. No one in their right mind is going to hold a 30 year T-Bond to maturity given the near 0% probability of generating a high real return. Likewise, given the risks in stocks I think you have to be somewhat selective about where you diversify. So, what can we do? I offered three keys:
- Control what you can control. The only way to guarantee higher returns is by reducing taxes and fees. My general rule of thumb is to try to always maintain a 366 day time frame and never pay more than 0.5% per year in fees.
- Diversify, but don’t diworsify. You can be diversified without owning everything in the whole world. This market environment is forcing us to be somewhat selective about where we diversify our assets. I focus on a cyclical approach.
- Learn to be dynamic without being tax and fee inefficient. A static 50/50 or 60/40 isn’t likely to generate the types of returns investors have become accustomed to. You can be strategic in your portfolio without being hyperactive. This could mean a more thoughtful approach to rebalancing or it could mean veering more into strategic asset allocation. “Active” is only a four letter word in this business if it’s tax and fee inefficient. After all, as I’ve discussed repeatedly, we all have to be active to some degree, but there are smart ways to do this and self destructive ways to do this….
You can watch the full interview here:
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.