Over the past several years, many articles have been written about the leading university endowment funds which had outperformed the stock market averages. Pension funds and then financial planners tried to mimic this model to produce superior investment results. The picture below may be familiar to you as your portfolio may look something like the pie chart.
A financial planner would explain that asset allocation is a technique that aims to balance risk and create diversification among major asset classes such as cash, bonds, stocks, real estate and commodities. In theory, each asset class has different levels of risk and return and is supposed to create a portfolio of uncorrelated assets, meaning that when one goes down, another goes up. However, we all know that in 2008, virtually all the asset classes moved in tandem as they all declined in unison.
Getting Back to Basics
The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. We agree with this statement but we believe that most financial professionals don’t know how to execute in making these decisions and instead just sprinkle a bit in every asset class. This is like an amateur chef throwing in every spice in the cabinet in hopes that it will season the dish; but in the end, it’s just a mess. The experienced chef knows what ingredients to use at what time and can often produce the greatest of dishes with very basic ingredients like salt and pepper. Investing, like cooking, needs to be brought back to basics. This means investing in stocks, US Treasury bills and bonds. Anything more just complicates the dish and doesn’t serve its purpose.
So how should your investment dish be prepared? Stocks are for the growth portion of your portfolio. When the economy is growing, equities should be featured in your portfolio. This will produce the best results. On the other side of the portfolio are US Treasuries. They provide income as well as safety as they are the safest fixed income vehicle that you can buy. Treasuries are backed by the US government and are highly liquid. For small investors, we recommend using iShares Barclays Short Treasury Fund (SHV). When a financial hurricane is on the horizon, Treasuries should be your main investments. Over the last 12 months, your portfolio should have been shifted toward US Treasuries, at least 75% of your total portfolio, as a defensive measure.
So what kind of dishes did your financial planner/advisor or stock broker cook up over the last year? Did they concoct a dish that made you sick to your stomach or did they stick with simplicity and make you feel good? Did they shift a significant portion of your assets to defensive vehicles like cash and Treasuries? If not, you should be asking why.