On asset allocation: How to thrive in every economic conditions and be your own financial advisor?

What drives people to invest? A willingness to multiply their money? A concern for the future of their retirement and children? A need to protect their finances against running inflation? The common point is inarguably the understanding of the importance of saving money and the compound interests. In achieving financial goals, if previously defined, helps a properly balanced portfolio adjusted for the future financial needs, time horizon and acceptance of the level of risk. Everyone who takes their finances seriously began to wonder how to invest the available resources safely enough to achieve satisfying returns with an appropriate reduction of the drawdown possibility.

In this article I will present the professionals’ and also my own approach to accurate asset allocation. We will look at how investing is understood by some of the finest specialists in this theme: Ray Dalio, Jim Rickards and David Swensen. I do not follow their approach uncritically but I have borrowed some assumptions from them and based on their advices I built my own portfolio. I hope this article will give you a broad spectrum of knowledge.

Importance of assets allocation

If you are living in one country, you get paid in the currency of this country and if you own a property in this country then you have already bet a lot on its economy. If the economic situation changes (hopefully for better- but who really knows?) it can have a significant influence on your private wealth. Reasonable balance and a diversified portfolio helps to protect the wealth.

There are limited amount of actions we can take to achieve our financial freedom faster. To increase the returns we can actually do only three things:

1. We can make better choices when selecting the type of investments like securities

2. We can have better timing

3. Right asset allocation

We have to know that the first two will almost never happen, at least never in the long run, which leaves us with only right asset allocation. This is the only aspect of investing which we really have control over and the most powerful determinate of returns.

If we would decide to put all our money in one company like Apple or to spend all our investible assets to buy a property then there is not any asset allocation. So what is an asset allocation? If there is a properly balanced portfolio between different asset classes with a possibly low correlation then we can talk about the asset allocation.

Professional investor’s approach

Ray Dalio

Ray Dalio is the co-chairman and founder at Bridgewater Associates- one of the world’s largest hedge funds. The company’s return in 2018 was 14.6% while S&P500 declined almost 7%. Ray Dalio is the originator of All Weather Portfolio. This portfolio construction allows investors to thrive in varying market conditions.

Source: www.etfdb.com

The back tests between 1984-2013 have shown that the derived performance of Ray Dalio’s All Weather Portfolio was 9.7% on average. The returns were positive 86% of the time (4 years were negative out of 29 years of back testing).

It means that if you invested $ 10,000 in 1984 by locating your assets according to All Weather Portfolio, the money would grow up to $ 146,552.15 after 29 years if you reinvested the profits.

An exemplary portfolio construction

Using Ray Dalio’s approach I would focus on ETFs to get wide exposure on the market. An ETF is a type of fund which owns various assets and is traded like a stock. I explained ETFs in my article How to invest around the world using one brokerage account?

PercentageAsset classFinancial instrumentTicker
40%Long-Term BondsiShares 20+ Year Treasury Bond ETF
TLT
30%Intermediate-Term BondsiShares 7-10 Year Treasur Bond ETF VTI
15%Stocks Vanguard S&P 500 ETF VOO
7.5%Gold Sprott Physical Gold Trust PHYS
7.5%Commodities ELEMENTS Rogers Intl Cmdty TR ETN RJI

If you want to explore further the subject of ETFs, I recommend you the book Common Sense on Mutual Funds by recently deceased John C. Bogle

Jim Rickards

Jim Rickards is the author of Currency Wars and The Road to Ruin. Both books are a deep analysis of the pathologies in current financial systems. He is a big enthusiast of a return to the gold standard. He advised on capital markets to the U.S. intelligence community. His clients include professional investors and government institutions.

Jim Rickards preferred portfolio allocation

Source: Trading Like a Business. Own elaboration

30% in Cash

Jim Rickards claims that we are on the late stage of the cycle and he recommends to keep at least one-third of your assets in cash or cash equivalents like treasury bills or notes.

20% in Private Equity

This part of the portfolio should contain assets like private equities and alternative investment like fine art and tech companies on early stage like start-ups.

20% in Real Estate

Jim Rickards recommend to put at least one fifth of investable assets in the real estate market including rent-paying properties and land. Farmland is also worth considering. If you don’t have enough resources to invest in real estate directly, I recommend you to look at REITs. REIT is a fund which manage income-producing real estate properties. I personally hold shares of Singapour REITs what I described further in the article How to invest in Singapore’s real estate market?

10% in Bonds

Jim Rickards recommends the 10-year Treasury notes. A 10-year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.

10% in Public Equities

According to Jim the branches worth to explore for potentials investment opportunities are natural resources and gold mining.

10% in Physical gold

Whatever is left of your investable assets, take 10% of that put it in physical Gold- not ETFs, not a bank storage because when you will need it the most, the banks are going to be closed.

One of the most liquid assets when it comes to investing in physical gold are gold coins. It is better to select numismatic coins instead of bullion coins. It is easier to confirm the authenticity of numismatic coins. The argument is also the fact that it has happened many times in history that numismatic coins were more worth than ordinary bullion coins. An example of such a coin can be the 20 Dollar coin (Liberty Head, Double Eagle).

David Swensen

David Swensen is the manager of the endowment fund at Yale Univeristy. David Swensem came to Yale in 1985 when the portfolio was worth less than $1 billion and it is $29.4 billion as of October 2018. The average investment return is 12.3% annually. During the financial crisis, between 2009 and 2010 the portfolio went up to $1.4 billion.

David Swensen emphasizes the importance of splitting the available assets between market-insensitive assets (cash, bonds and absolute return) and equities (shares, ETFs and REITs). The Swensen portfolio is divided between equities and fixed income assets in the proportion of 70/30.

Source: Trading Like a Business. Own elaboration

The Swensen portfolio consists of six core asset class allocations:

Equities:

  • US equity: 30%
  • Foreign developed equity: 15%
  • Emerging market equity: 5%
  • US REITS: 20%

Fixed income:

  • US Treasury bonds: 15%
  • US TIPS: 15%

Exemplary construction

Percentage Asset classFinancial instrumentTicker
30%US equityVanguard S&P 500 ETF VOO
15%Foreign developed equityVanguard FTSE Developed Markets ETF VEA
5%Emerging market equityVanguard FTSE Emerging Markets ETF VWO
20%US REITSiShares US Real Estate ETF IYR
15%US Treasury bondsiShares 7-10 Year Treasury Bond ETF VTI
15%US TIPSVanguard Short-Term Inflation-Protected Securities ETF VTIP

Milan Reder’s portfolio

Do not think that calling my portfolio by my own name is a result of vanity. I am not trying to put myself in the circle of the most outstanding investors of the present times, who manage billions of dollars. I just want to say that the following thoughts are only the result of my own deliberations and experiences and that this is the approach is which I use in my own investing process.

Long-Term investing

I am a stock market enthusiast. Owning shares is the best way to become a part of well prospering businesses. As a single citizen you have the opportunity to benefit from the profits of companies that hire thousands of employees and generate billions of profits, from operations carried out often on several continents.

Historical data shows that the stock market always goes up in the long term. The U.S. stock market, the biggest market in the world, has experienced much more positive years then negative ones. Since 1925, during 94 years long tracking history, 68 years ended up with a positive calendar year return while only 25 years were negative. Every bear market ends with an even greater bull market.

Source: Morningstart Direct

The average market correction is short-lived and lasts anywhere between three and four months. A bear market lasts longer but creates an even bigger opportunity. The average time of bear market is 367 days and occurs 1 out of every 3.5 years. When the market shows weakness the media are panicking and releasing the virus of anxiety among investors. We can see the headlines like “Another recession is coming” or “China’s slowdown will pull down the world’s economy”. Cautious investors don’t bother with media noise. It should be an alert signal that the opportunity is just around the corner. When S&P500 falls 3 weeks in a row, with the final week down more than -7% then the index recovers with an average return of 31% within the next 12 months. It does apply to 100% of cases though!

Source: bullmarkets.co

Everyone knows that after winter it’s time for spring. Long-term investing is a win-win game.

Asset allocation

My portfolio is a combination of cash, stocks and ETFs.

Source: Trading Like a Business. Own elaboration

30% cash

As you probably noticed there is no bonds in my portfolio. I still cannot bring myself to invest in bonds. I rather prefer to sit on cash ready to take advantage when the opportunity arrives. Depending on the market condition but usually the proportion between stocks and cash is between 70% and 30% respectively. As I mentioned before, the cash component should rather be based on the currencies different from the main source of our income. If we get paid in the US dollar than the cash part of the portfolio should be based on one or two of the safest currencies in the world right now: Euro, Norwegian krone, Polish zloty, Singapore dollar, Swiss franc.

Stocks and ETFs

I am in favour of diversification but in small doses. I’m trying to figure out which assets are good enough to make them all my friends for the long-term. The choice falls on 10 different assets including stocks and ETFs. Not more and not less. The point is to select fewer stocks which will make a very positive outcome but we cannot get to excited about too few companies because we need to keep in mind the issue of risk balance. Because this component of my portfolio equals 70% I allocate 7% on each company or ETF. I am focused on mid-cap or large-cap companies which exist for more than 15 years and/or survived at least one recession or crisis. If they pay dividends it’s even better. To get exposure on a broader market I select ETF which holds companies from different countries or sectors. Sometimes it can be only a commodity.

I took the matter further in the special report:

Precious metals

The market prophets always foretell apocalypse advising to put all in gold. The truth about Gold is that it has performed worse than almost every major asset class (besides cash) going all the way back to the Great Depression. Due to the fact that they can be liquefied outside the system (like cash) it makes it an interesting asset. But regarding gold I use the principle which I called 101%: One hundred and one percent of the portfolio. If you have already allocated all your investable assets and there is still something left it’s worth to consider a purchase of a few golden coins or silver spoons.

Exemplary construction

Percentage Asset classFinancial instrumentTicker
30%CashEuro, Norwegian krone, Polish zloty, Singapore dollar, Swiss franc, US DollarEUR, NOK, PLN, SGD, CHF, USD
7%EquityKaz MineralsKAZ
7%Equity China Mobile Limited CHL
7%Equity Wheaton Precious Metals WPM
7%Equity Kruk SA KRA
7% EquityNutrienNTR
7%ETF Lion-Phillip Singapore’s REITs CLR
7%ETFVanEck Vectors Rare Earth/Strategic Metals ETF REMX
7%ETF iShares MSCI Turkey ETF TUR
7%ETF Global X MSCI Pakistan ETF PAK
7%ETF United States Oil USO

Summary

Asset allocation is the most powerful tool that we as aware citizens, responsible parents or as cautious investors (you name it) have. Following one of the greatest minds in investing business we can develop our own strategy and spread the risk over different asset classes. It can help to avoid the loses and allow the profits to grow.

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