Author Topic: Asset allocation: Non-equity component  (Read 1747 times)

mucstache

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Asset allocation: Non-equity component
« on: July 05, 2020, 12:58:40 AM »
Hi everyone,

as I revisit my asset allocation for the next ~10 years, I wonder whether I should move my non-equity component to a better diversified portfolio.
Based in Europe, 32 years old, if that matters (I believe it shouldn't).

Currently I am at 70% global stock portfolio, 30% Cash (split approx. 60% EUR, 30% CHF, 10% USD).

My problems with this:

1) 30% Cash seems a bit excessive to me, especially since this is now approaching six figures. While guaranteed in nominal terms, I am not sure about real performance. So I am looking at alternatives.

2) A classic bond component does seem to be outdated: Except short-term USD govt bonds, EUR & CHF bonds yield negative in nominal (!) terms. Better keep those currencies in cash I suppose.
So bonds are not a good solution except for the USD component, which I might increase to 30% of the remaining cash.

3) Based on what's going on (money printers around the world going 24/7), I am not sure if cash/bonds will keep up their value.
Value defined as in "How many "potatoes/sqft living space/clothing items/gadgets/..." does 1 unit of my cash buy me in the future?"

I am considering broadening the 30% portfolio into three categories:

1) Gold
2) REITs
3) Diversified cash (still EUR/USD/CHF, but more equal split, potentially adding SGD)

Intuitively I'd go with 15% Gold, 10% REITs, 5% Diversified Cash. (Note: EUR cash emergency fund kept seperate)

What do you all do? What do you think about this?

DalioGold10

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Re: Asset allocation: Non-equity component
« Reply #1 on: July 05, 2020, 06:11:59 AM »
Hi everyone,

as I revisit my asset allocation for the next ~10 years, I wonder whether I should move my non-equity component to a better diversified portfolio.
Based in Europe, 32 years old, if that matters (I believe it shouldn't).

Currently I am at 70% global stock portfolio, 30% Cash (split approx. 60% EUR, 30% CHF, 10% USD).

My problems with this:

1) 30% Cash seems a bit excessive to me, especially since this is now approaching six figures. While guaranteed in nominal terms, I am not sure about real performance. So I am looking at alternatives.

2) A classic bond component does seem to be outdated: Except short-term USD govt bonds, EUR & CHF bonds yield negative in nominal (!) terms. Better keep those currencies in cash I suppose.
So bonds are not a good solution except for the USD component, which I might increase to 30% of the remaining cash.

3) Based on what's going on (money printers around the world going 24/7), I am not sure if cash/bonds will keep up their value.
Value defined as in "How many "potatoes/sqft living space/clothing items/gadgets/..." does 1 unit of my cash buy me in the future?"

I am considering broadening the 30% portfolio into three categories:

1) Gold
2) REITs
3) Diversified cash (still EUR/USD/CHF, but more equal split, potentially adding SGD)

Intuitively I'd go with 15% Gold, 10% REITs, 5% Diversified Cash. (Note: EUR cash emergency fund kept seperate)

What do you all do? What do you think about this?

Hi,

REITs do not offer meaningful diversification in your case, i.e. you are already 70% invested into stocks. Risk and return of REITs have been explained by a portfolio of small value stocks and corporate bonds. Both are exposed to the same risks as the 70% stocks of your portfolio. You need to diversify away from the same risks that stocks gives you explore to.

In order to diversify your remaining 30% allocation I would choose gold/cash/managed futures ETFs.
I am also based in Europe, so regarding your cash exposure it does not make too much sense to hassle and split it among so many currencies. Please note that you are already exposed to currencies through your equities holding, which are unhedged in a global index.

If you are interested in managed futures, JP Morgan has a version accesable for the European investors like us, UCITS complaiant:
https://am.jpmorgan.com/gb/en/asset-management/gim/adv/products/d/jpm-managed-futures-ucits-etf-usd-acc-ie00bf4g7290

Both gold and managed futures are uncorrelated to stocks and bonds, hence represent good diversifiers. Please note that, at least for managed futures they are not intended to mitigate the negative tail risk of equities despite their good performance in 2008 crisis.

Hope it helps !
« Last Edit: July 05, 2020, 09:27:30 AM by DalioGold10 »

ChpBstrd

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Re: Asset allocation: Non-equity component
« Reply #2 on: July 05, 2020, 01:09:42 PM »
Do you have access to options? If so, you could turn your allocation up to about 95% stocks and hedge your exposure to losses even better than your 70/30 allocation currently does. That is, you could put a floor under your portfolio and drop your volatility regardless of the scenario, rather than just having a rebalancing opportunity.

PDXTabs

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Re: Asset allocation: Non-equity component
« Reply #3 on: July 05, 2020, 04:32:54 PM »
What do you all do?

I, personally, would go to 100% equities.

helloyou

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Re: Asset allocation: Non-equity component
« Reply #4 on: July 05, 2020, 06:16:14 PM »
I intend to be at least 10% on commodity. It can be gold, but could also be silver, copper, oil, etc. If price makes sense

Andy R

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Re: Asset allocation: Non-equity component
« Reply #5 on: July 05, 2020, 09:08:59 PM »
As mentioned earlier, REITs are stocks and have stock market risk. If you want some REITs, carve it out of your stock portfolio, not your bond portfolio.

Gold can be ok but you need to be keenly aware that the volatility of gold is very high. On it's own, an asset that has no real long term return but can double or halve in 15 year periods looks pretty awful, although if you're ok with that happening for the sake of a (possible) portfolio-wide benefit due to low correlations with stocks and bonds, it may be ok, but you really need to be ok with the volatility.

Unfortunately I don't have a nice recommendation. Every option looks kinda crap in some way or other.

The_Big_H

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Re: Asset allocation: Non-equity component
« Reply #6 on: July 05, 2020, 10:13:34 PM »
I think I would just keep it liquid cash and 'live' with it.  Its not there to make you money so much as it is to soften the blow of market dips and for opportunities / rebalancing.

IMO worrying about sub ~1% yields isn't worth it,  0% isn't much different that 1%, really.  Either 'live' with it in highly liquid cash forms or start messing with other risky stuff like, as you say, gold, or my personal favorite junk-ish bonds (in the 4-6% yield ranges).  I would never invest in long term bonds to get the rate up, I'll take the risk on the quality side.

Or keep that 30% cash around and commit to using it the next stock market dip.  Maybe make a rule something like: "I will invest 20% of this cash every time the market drops 10%". A theoretical 50% market crash puts you all in, and either we recover from that crash and you will be well off, or it never recovers in which case we (and the world) are screwed anyway

Andy R

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Re: Asset allocation: Non-equity component
« Reply #7 on: July 05, 2020, 10:38:16 PM »
Or keep that 30% cash around and commit to using it the next stock market dip.  Maybe make a rule something like: "I will invest 20% of this cash every time the market drops 10%". A theoretical 50% market crash puts you all in, and either we recover from that crash and you will be well off, or it never recovers in which case we (and the world) are screwed anyway

That is missed by most people.

A big reason that bonds help, is not just that historically they have had a higher return than cash, but that you rebalance by selling equities into them when equities are high, and selling some cash back to buy equities when they are low. You can still do this with cash and the result is that by doing this, 20% in cash is going to have much less than 20% drag on expected returns relative to 100% equities.

mucstache

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Re: Asset allocation: Non-equity component
« Reply #8 on: July 05, 2020, 11:43:03 PM »
Thank you very much everyone!
A couple of questions:

@DalioGold10 I checked the portfolio of the managed future that you linked. It is literally 80% Cash. What's the use of this? Is this an exception for managed futures ETFs?

@ChpBstrd How much would this roughly cost in % of portfolio value? And is there a way to automate this? I have access to options, no problem - but it seems pretty complicated to me.

@The_Big_H Good strategy, especially if done with a written investment policy like stated by you. My worry with this is that we won't see another market drop significant enough to get most money invested before my cash deteriorates significantly in value. Government's around the world are heavily incentivized to drive inflation as the only remaining real strategy. If they succeed, cash will be worth a lot less over a few years.

DalioGold10

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Re: Asset allocation: Non-equity component
« Reply #9 on: July 06, 2020, 02:12:46 AM »
Thank you very much everyone!
A couple of questions:

@DalioGold10 I checked the portfolio of the managed future that you linked. It is literally 80% Cash. What's the use of this? Is this an exception for managed futures ETFs?


The cash is actually used as collateral/margin.
Please note that futures are basically standardized paper contracts. The broker/house needs you to deposit cash/collateral to cover for your positions.

Best.
« Last Edit: July 06, 2020, 02:57:13 AM by DalioGold10 »

ChpBstrd

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Re: Asset allocation: Non-equity component
« Reply #10 on: July 06, 2020, 10:39:53 AM »
@ChpBstrd How much would this roughly cost in % of portfolio value? And is there a way to automate this? I have access to options, no problem - but it seems pretty complicated to me.

The cost of hedging with options can be anywhere from a negative number to several % per year. It depends on how much downside risk you are willing to accept and how much upside risk you are willing to give up. The simplest hedging strategy is the protective put, where buy the stock and then buy a put option on the stock. The price of the option, and the amount of protection it provides, is determined by its strike price - I.e the price at which it would allow you to sell your shares in the event of a downturn.

With SPY at $317, protective put positions can be bought at the following prices for each level of protection. Remember that if the stock plummets, you lose the gap between what you paid and the strike price plus the cost of the put. These positions offer 2.44 years of protection. So to annualize the cost, take the percentage increase in cost and divide by 2.44.

SPY only - $317
$250 put - $339.44
$275 put - $346.78
$300 put - $356.16
$320 put - $364.12

As you can see, option prices are high right now due to volatility, so itís not an ideal time to buy a protective put. However you can offset the cost of the put by selling a call option against the stock. This is called a collar strategy and it limits both your potential downside and your potential upside.

E.g.
Buy SPY for $317
Buy 275 put for $30.35
Sell 360 call for $18.00

Net cost: 317+30.35-18=$329.35 (about 4% higher than just the stock)
Max downside: 317-275+30.35-18=54.35 (16.5% plus dividends)
Max upside: 360-317-30.35+18=30.65 (9.3% plus dividends)

Those results may not seem impressive over a 2.44 year period, but with the limited downside I think the proper comparison is to a mostly bond portfolio. Also, if you think inflation might be coming, youíd want to avoid todayís low-yielding bonds like the plague because they could lose a large amount of value if interest rates were to rise by only a couple percent (for fun and terror, do the PV math in excel). You can get different payoffs by choosing different strike prices.

facepalm

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Re: Asset allocation: Non-equity component
« Reply #11 on: July 14, 2020, 11:47:32 AM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)

Buffaloski Boris

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Re: Asset allocation: Non-equity component
« Reply #12 on: July 14, 2020, 01:41:11 PM »
When I saw this I was thinking along the lines of : what creative investments are there that donít involve equities or financial instruments at all? Iím reminded of an article MMM wrote some time ago noting that an investment with a great payback was insulating his house.

Shouldnít we think about this sort of stuff as well?

ChpBstrd

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Re: Asset allocation: Non-equity component
« Reply #13 on: July 14, 2020, 02:00:27 PM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)
Wouldn't cash do the same, without the interest rate risk?

Buffaloski Boris

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Re: Asset allocation: Non-equity component
« Reply #14 on: July 14, 2020, 03:15:32 PM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)
Wouldn't cash do the same, without the interest rate risk?

It would. Whatís the difference in rebalancing to cash that pays 0% interest and treasuries that pay not much more? Some background noise level of return? Iíd rather have the flexibility of cash.

The_Big_H

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Re: Asset allocation: Non-equity component
« Reply #15 on: July 15, 2020, 03:21:20 PM »
@The_Big_H Good strategy, especially if done with a written investment policy like stated by you. My worry with this is that we won't see another market drop significant enough to get most money invested before my cash deteriorates significantly in value. Government's around the world are heavily incentivized to drive inflation as the only remaining real strategy. If they succeed, cash will be worth a lot less over a few years.

If 1st world governments are incentivized to drive inflation they've been doing a piss poor job at it the last 20 years.  I mean we (the US) ran $2T out of the money printers and we are still at 1% inflation.  Now if we were to have sudden inflation beyond what we have seen in the 21st century so far that would cause:
1) a housing price drop, as mortage rates go up people can afford less and less (payments go up) thus prices have to stagnate or fall.
2) your bonds will become worthless.  Who will want a 1% bond when new issue bonds go up to 5% in a rising interest rate and inflationary environment.

So, if you are worried about inflation a whole lot, forget cash, and bonds.  At that point its just gonna be stocks and maybe PM?

ChpBstrd

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Re: Asset allocation: Non-equity component
« Reply #16 on: July 16, 2020, 01:45:27 PM »
@The_Big_H Good strategy, especially if done with a written investment policy like stated by you. My worry with this is that we won't see another market drop significant enough to get most money invested before my cash deteriorates significantly in value. Government's around the world are heavily incentivized to drive inflation as the only remaining real strategy. If they succeed, cash will be worth a lot less over a few years.

If 1st world governments are incentivized to drive inflation they've been doing a piss poor job at it the last 20 years.  I mean we (the US) ran $2T out of the money printers and we are still at 1% inflation.  Now if we were to have sudden inflation beyond what we have seen in the 21st century so far that would cause:
1) a housing price drop, as mortage rates go up people can afford less and less (payments go up) thus prices have to stagnate or fall.
2) your bonds will become worthless.  Who will want a 1% bond when new issue bonds go up to 5% in a rising interest rate and inflationary environment.

So, if you are worried about inflation a whole lot, forget cash, and bonds.  At that point its just gonna be stocks and maybe PM?

In a 5% inflation scenario, I would much rather watch my cash lose 5% than watch what would happen to my stocks or bonds. 

mucstache

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Re: Asset allocation: Non-equity component
« Reply #17 on: July 16, 2020, 10:38:18 PM »
What makes you assume that interest rates would go up to match inflation? What governments really need is inflation that exceeds interest rates to devalue debt in real terms.
In this case, real estate prices therefore would not necessarily have to fall. Stocks might do ok to well if companies are able to pass on rising cost (and they are on average, otherwise there would be no inflation).

Paul der Krake

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Re: Asset allocation: Non-equity component
« Reply #18 on: July 16, 2020, 11:33:38 PM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)
Wouldn't cash do the same, without the interest rate risk?

It would. Whatís the difference in rebalancing to cash that pays 0% interest and treasuries that pay not much more? Some background noise level of return? Iíd rather have the flexibility of cash.
Bonds swing in value, ideally in the opposite direction than stocks. Cash doesn't.

OP, where in Europe are you based and did that influence your choice of currencies as core holdings?

mucstache

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Re: Asset allocation: Non-equity component
« Reply #19 on: July 16, 2020, 11:39:10 PM »
Germany - Euro Zone. Don't see any future for the euro ;)

Buffaloski Boris

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Re: Asset allocation: Non-equity component
« Reply #20 on: July 17, 2020, 04:58:54 AM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)
Wouldn't cash do the same, without the interest rate risk?

It would. Whatís the difference in rebalancing to cash that pays 0% interest and treasuries that pay not much more? Some background noise level of return? Iíd rather have the flexibility of cash.
Bonds swing in value, ideally in the opposite direction than stocks. Cash doesn't.


Thatís the idea of bonds but that doesnít work out so well when youíre at very low or negative interest rates. There is a limit to bond holders being willing to pay for the dubious privilege of lending money. Its smarter to pay to store currency rather than take a loss on lending it. So the upside risk of owning bonds and having a price swing in your favor is limited. The risk is very much on the downside.

ChpBstrd

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Re: Asset allocation: Non-equity component
« Reply #21 on: July 17, 2020, 09:22:45 AM »
You don't buy bonds for their returns. You buy bonds to stabilize the value of your portfolio. (Bogleheads Wiki)
Wouldn't cash do the same, without the interest rate risk?

It would. Whatís the difference in rebalancing to cash that pays 0% interest and treasuries that pay not much more? Some background noise level of return? Iíd rather have the flexibility of cash.
Bonds swing in value, ideally in the opposite direction than stocks. Cash doesn't.
For a 1 year term, I can either buy a treasury yielding 0.14% or an FDIC insured CD yielding 1%. The yield on the treasury would have to swing from 0.14% to -0.6% before the first coupon payment in order for my treasury to appreciate a greater amount than the extra interest I would have received on my cash investment.

Yes, the swing is greater for 10 year treasuries if yields drop from todayís 0.28% to, say, zero a year from now. In that event appreciation of up to 2.5% might be possible (!!!!). Of course, in exchange for that opportunity I take the risk of a big decline. E.g. if rates go up to only 1% a year from now, my now 9-year treasury would have lost 6.18% in market value.

The pattern for the last few years has been falling interest rates that push up both stocks and bonds. The usual / theoretical/ pre-QE pattern was for interest rates and stocks to rise as the growth phase of the business cycle started generating inflation, and this would hurt bonds. The pattern would reverse on the downside of the business cycle as inflation and yields fell together. Itís been over a decade since this sort of normal capitalism has been in effect, though, and the level of QE has only multiplied in recent months.

Fuzz

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Re: Asset allocation: Non-equity component
« Reply #22 on: July 17, 2020, 12:34:35 PM »
Gold just bugs me as an asset class. It seems like the epitome of the greater-fool investment. Someone else in the future will pay you more. Why? Because...

It doesn't produce anything. It has no intrinsic value. But there are a lot of examples of scared people buying it, and lots of people selling it based on fear (look at the coin ads targeted to seniors).

Lots of folks disagree, and it is a recognized part of a portfolio, but I would put more cash in a bond index, or screw around with crowdsourced real estate loans, or something, before I put money in gold.

Also, once you get to high absolute numbers in your investments, my position is that you don't need an e-fund. If you have close to six figures in cash, you can have close to six figures in equities/bonds. If you had an emergency, you could then (1) sell the equities; or (2) get a loan against the equities. Lots of people point out the counter-argument that your emergency could also be the same time as a downturn in the market, and you'd lose money when you sell the equities. What's the risk of that? Low-ish for lots of folks (how many times have you used your e-fund? I bet never, and if you did, that what you spent was a fraction of six figures). What's the cost of that? Opportunity cost, which can be high-ish for a six figure fund.

However, in a true emergency (medical or family), the money isn't the point, and you spend it freely to take care of health or family.

mucstache

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Re: Asset allocation: Non-equity component
« Reply #23 on: July 17, 2020, 10:57:23 PM »
Well, the same is true for cash. No intrinsic value, greater fool etc.
In the current times particularly so.

sherr

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Re: Asset allocation: Non-equity component
« Reply #24 on: July 20, 2020, 07:44:13 AM »
Lots of people point out the counter-argument that your emergency could also be the same time as a downturn in the market, and you'd lose money when you sell the equities. What's the risk of that? Low-ish for lots of folks (how many times have you used your e-fund? I bet never, and if you did, that what you spent was a fraction of six figures). What's the cost of that? Opportunity cost, which can be high-ish for a six figure fund.

I think your first point is off. You are most likely to need your emergency fund at precisely the same time as the stock market is hurting (and layoffs are happening). There is an opportunity cost though, you're right about that.

vand

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Re: Asset allocation: Non-equity component
« Reply #25 on: July 20, 2020, 11:11:50 AM »
You don't buy bonds for their returns.

Said no bond investor in the last 45 years.

Paul der Krake

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Re: Asset allocation: Non-equity component
« Reply #26 on: July 20, 2020, 11:34:42 AM »
You don't buy bonds for their returns.

Said no bond investor in the last 45 years.
I don't buy bonds for their returns, but I ain't turning them down when they show up anyway.

dizzy

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Re: Asset allocation: Non-equity component
« Reply #27 on: July 20, 2020, 01:05:31 PM »
I am a nobody, but yeah, I'm feeling similar to OP.  I don't feel great about bonds, especially in this environment.  I sold in March and bought discounted equities with it in the portfolio I had at the time (Paul Merriman 10-fund).  That's a value portfolio which has been doing super meh and IDK if I'm going to continue with it.

What I am doing:
Purchasing a combo of gold, silver (probably an even better value right now), and other metals.  Combo of miners + physical holding ETFs.  I have it currently at 15% of my IRA accounts but may increase to 20-25% of my total IRA accounts.

Cash- I have significant holdings here- currently 50% of my worth (lil over 30k, most of this has come in last 2-3 months).  I earn a ton more doing bank sign up bonuses and kickfurther than I can reasonably expect in the market, AND I have more liquidity there in case of emergency.  The worst of it is in 5-6% savings accounts (netspend, DCU, and now a new one called Yotta- lmk if you need referrals), even that is better than bonds after inflation.

Real estate- I don't own a house, and have given up on that, since I moved in with my bf who owns one.  I have a REIT in my 10-fund plan above, it sucked butt this year.  I have been dabbling on alternative RE opportunities, and am getting way better with my groundfloor account which also offers a IRA option (currently I have like $20 in taxable just to see how it worked).  I may also use Fundrise, which also has a low minimum to start.

Wine- I'm very interested in Vinovest, I started a $1k position here.  I like that the avg return is ~13% (not including inflation) AND that it's not correlated to the market.  I may open a self-directed 401k where I can include this, currently you can't put this in a normal IRA

Crypto- feel bullish on this in the next year or two.  I used to get a lot of physical cash from working, I'm not now so much.  We have a bitcoin atm at the local convenience store in the hodunk town I moved to, IDK why, it doesn't have fees.  I plan to put the occasional tips I get in there, and keep what I have from signup bonuses from all the apps.

With any of the earnings I have throughout the year with all this alternative stuff I will then stash it into IRA's (solo 401k + HSA + roth or trad depending on my income).  I just can't see the point of it throughout the year sitting in stocks earning meh when it could be having definite positive growth outside of it.