For as long as I’ve been in financial services, advisors, when designing a portfolio, have started with a ‘balanced’ allocation and then added or subtracted equities to fit the risk tolerance of the individual client. The starting point, or ‘balanced portfolio’ has been a percentage split of 60/40 with the 60 being equities and the 40 being bonds. Most investors are actually even more diversified with varying percentages of small caps, foreign stocks, high yield bonds, and perhaps commodities or REITS. Still a simple mix of 60% S&P500 Index* and 40% Barclays US Aggregate Bond Index have historically provided a good balance between risk and conservative investments.

This has been a good answer because it worked. The stocks provided appreciation and dividends and the bonds give the portfolio yield, capital appreciation (sometimes), and acted as a volatility reducer when stocks tanked. In addition, over many of the historical time periods, the portfolios could be expected to produce 5, 6, or perhaps even 7% distributions. So, this has worked well for an average investor. Hence the phrase ‘If it ain’t broke don’t fix it’. But this could become a problem as we move forward. This simple approach may no longer work, and the primary problem is the ‘40’ in the formula – the bonds.

Given the current historically low interest rates, the chances of bonds producing returns anywhere near their historic returns are about the same as the likelihood of snowfall today in Phoenix (current temperature 101 degrees). As interest rates go up, bond prices go down so the upside possibilities of bonds, is pretty small.

SO, what happens to the traditional 60/40 portfolio? (Stay with me here.) If we had an expected return of 8% but now the fixed income will generate only 2% returns, how much will the remaining 60% in equities need to return to bring the portfolio up to the expected 8%? I’ll save you the math exercise – the equities need to generate 12%. And to add insult, a 2% return on bonds may be a tad generous. A larger rise in interest rates could push bonds into negative returns areas.

And this leads to some unpleasant options. These are either lowering the return expectation of the portfolio overall, increasing the equity portion and adding more risk, or crossing fingers and hoping that markets perform better than expected to make up the difference.

Bottom line: It may be time to rethink the allocation of the 40% or have a visit with your advisor for suggestions on what might be changed.

Market Minute – Economists Are Good at Predicting Markets – NOT!

During the past week I had the chance to once again spot key articles on ‘financial’ websites that were somewhat contradictory. One suggested that there was a big bear market ready to pounce, and another that suggested we’ll have positive returns for the next several years. I’d guess that one of those is wrong. Yet we as investors, do give credence to the headlines and especially to economists that make predictions about markets.

It is odd that one of the components of the Index of Leading Economic Indicators (designed by economists) is the performance of the stock market. The truth is, however, that the stock market is better at predicting the economy. Upon leaving grad school in the early 1970’s for my initial foray into the financial services world, I was pleased to note that a young economist named Alan Greenspan stated, ‘Now may be the best time in history to buy stocks.’ Hurray- blue skies ahead!

This proclamation was made just days before the beginning of the 1973-74 bear market that took the S&P 500 Index down over 48% in a little less than 2 years’ time. 

The current markets are trending up, although in a somewhat schizophrenic manner. The Wall Street Waltz is still taking two steps forward and one step back. We are in the middle of a typically less-than-positive month, but are also ready to enter the last quarter of the year, which is often the strongest part of the year for markets. I’m comfortable suggesting that we are somewhat optimistic that this year will end positively for the markets, in spite of some economists’ predictions, and in agreement with others. 

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk

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*The indices are representative of domestic markets and include the average performance of groups of widely held common stocks. Individuals cannot invest directly in any index and unlike investments, indices do not incur management fees, charges, or expenses, therefore specific index returns will be higher. Past performance is not indicative of future results.