It’s time to revisit strategies for diversifying your  portfolio 

By John Grace

Contributing Columnist

Over my 44 years in the securities business, one of the conventional hallmarks of financial advice that has stood the test of time has been to diversify portfolios 60% to equities and 40% to bonds. In 2022, however, investors who followed that advice might have seen their portfolios lose value.

Indeed, Bank of America in October found that the traditional 60-40 portfolio experienced the worst performance in a century, down 34% for the year. The theory is that bonds and stocks are negatively correlated, but last year the combination plunged in tandem.

In 2022 bond investors suffered the worst returns of any they have in the last 250 years, says Edward McQuarrie, investment historian and professor emeritus at Santa Clara University. McQuarrie explained that inflation is, in short, “kryptonite” for bonds. The stock market in 2022 was characterized by a lot more pain than gain, making it the worst year for the S&P 500 since the 2008 financial crisis.

What I would say is that the message, “Over the long haul, you’ll always be OK in a conventional portfolio” is based on a limited view of history and the concept can fail miserably when investors want, or are required, to sell to meet income requirements.

In a Value Walk interview Phillip Toews, CEO of Toews Asset Management, notes that history shows periods when the traditional 60-40 portfolio didn’t work at all. Toews found, for example, a balanced 60-40 portfolio was down 72% during the Great Depression, which left investors, assuming zero withdrawals, with a mere 28% of their value after the first two-and-a-half years. 

After that decline the market recovered in fits and starts for about five years, but then another five-year bear market hit, which would’ve caused many investors to run out of money if they were taking distributions. Toews went on to point out a little known fact that we have discussed here. Japan’s stock market is still more than 30% below where it closed in 1989. Imagine being an investor in Japan and try and wrap your mind around it: With no withdrawals, your stocks are still not back to even for 33 years now.

As we review 2022 returns we find that there were ways to smooth out performance numbers. For example, the Bloomberg Commodity Total Return Index was up 16.09% in 2022. Although you had to have an allocation to it in advance, for it to have an impact, this is why diversification is so important.

We also found that, after a market decline, cash flow can be difficult to maintain. But putting idle cash to work increased the odds of investors maintaining preferred income through age 100.

 While no one can predict the future, we can prepare for the unexpected. And we can learn from the past. “The longest bear market on record lasted 929 days,” according to Dent Research. “The current bear market may top it.” Why? 

Dent Research asserts the larger inversion. The downturn that was most similar to now took place after the first tech bubble in May 2000. That decline took 645 days to bottom, which may suggest that the next one might take place around September 2024. 

The S&P 500 peaked Jan. 4, 2022, and it takes “a first crash of over 30% to break a bubble like this,” per Dent Research. That might lead to a replay of 2000-2002 when the Dow was off 80%, taking 12 years to fully recover without redemptions.  

After quadrupling in the last half of the 1990s, the tech-heavy Nasdaq Composite took 15 years to get back to even, with no withdrawals, after dropping about 90 percent, according to The Motley Fool.

In a recent Financial Times piece, Allianz CEO Mohamed El-Erian wrote, “Greater selectivity, smart structuring trump more often the lower fees on passive vehicles” in a murky economic climate of high-interest rates and low liquidity. 

Now is the time to consider exchanging a passive investment style for an active one and adding alternative investments that are comprised of non-traditional asset classes, such as private equity, hedge funds, real estate and commodities, i.e. alternatives to fixed income and equity securities. 

As we prepare for Super Bowl Sunday, the last thing you want to look forward to on the field or when playing the money game is a “hail Mary” pass just to get back in the game. It might be possible to win by losing less.

John Grace is a registered representative with LPL Financial. His On the Money column runs monthly in The Wave. The opinions expressed here are for general information only and are not intended to provide specific advice or recommendations for any individual.

LIFTOUT

Japan’s stock market is still more than 30% below where it closed in 1989. 

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