The traditional Single-Asset Investing Strategy emphasizes purchasing one item at a time and holding it for a long time. In the 1980s, this strategy was effective, primarily because interest rates were high and assets were not correlated. But in 2016, the financial markets are displaying some markedly non-traditional features.
Low Interest Rates
In the 1980s, Federal Reserve Chairman Paul Volcker raised interest rates to reduce speculation. Thereafter, investors could purchase a certificate of deposit or simply open a savings account and earn healthy returns.
But after the 2008 sub-prime mortgage crisis, Federal Reserve Chairman Ben Bernanke did the opposite. He lowered interest rates to create “ZIRP” and “Quantitative Easing.” Did Bernanke want to increase speculation? This policy has created historically low bank savings rates.
With ZIRP in place for 2016, the old Single-Asset Investing Strategy might not even deliver profits above inflation. Many financial advisors recommend a multi-asset investing strategy as the answer, due to high rates of cross-asset correlation, low returns and risk tolerance tools.
1. Stock & Bond Correlation
Traditionally, the “Rule of 100” could be used to diversify your portfolio, simply subtract your age from 100, and that should be your equities portfolio distribution. Just add bonds and your portfolio was balanced because, historically, stocks and bonds were not correlated.
But in 2016, some experts see a correlation between stocks and bonds. Advisors will state that passive diversification is not a sufficient method of risk management in this environment. Customized hybrid financial instruments, such as collateralized loan obligations (CLOs), have blurred the lines between traditional asset classes.
2. Low Returns
The Federal Reserve is using ZIRP to 1. Protect the housing market and 2. Provide cheap capital. When the Fed bailed out the banks in 2008, it purchased the non-performing mortgage-backed securities (MBS) therefrom. If interest rates were allowed to rise dramatically, more homeowners would default and the Fed’s balance sheet would be further impaired.
In many ways, the individual is competing with the Fed as a capital source. Of course, the Fed will win the battle every time by offering ZIRP capital. Due to this new reality, investors might need to expand their attention beyond “stock-picking.”
When in Rome …
Since 2008, many banks have earned ripe profits, so how have they done it? The banks have borrowed capital cheaply and re-invested it rapidly (i.e. high-frequency trading). How can investors profit from this asset allocation strategy?
3. Risk Tolerance
Asset allocation is explained adeptly by the March 20, 2016 Mitch Tuchman Forbes article as properly investing your limited funds to gain the highest returns. Businessman Jim Rogers earned such astronomical returns at the Quantum Fund by optimizing his return on investment (ROI).
Chasing returns has become the norm in the modern financial environment
Roughly 80 percent of a portfolio’s risk and return comes from asset allocation, and only about 20 percent comes from individual security selection. The wisest investor understands when their asset has reached its peak, then they can sell it and take their profits. Even the old Pony Express knew that it could only ride a horse for so long.
If an investor is not happy with the low interest rates, then they might need to consider their own risk tolerance. A multi-asset investing strategy involves “re-allocation” of a financial portfolio when profits have been made, in many ways, it is how the Gold ETF is run. As the gold price changes, the fund manager must adjust the amount of the physical metal held by the fund. The same process is necessary with this investing strategy.
Modern technology, hybrid financial instruments, and low interest rates are the perfect storm for a multi-asset strategy, and while the strategy is more complex, it remains rooted in the fundamentals of asset allocation. When you have limited funds, you must continually adjust the allocation to respond to market changes, so this allows you to remain the “immovable force” that remains profitable in any market.
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