Why the Standard Stocks + Bonds Portfolio Underperformed
Portfolio diversification can mean different things to different people, depending on their financial plans and goals. However, the balance between growth and stability is almost certainly a characteristic of any diversified portfolio that most of us agree with.
A 60/40 portfolio is one of those simple diversified portfolios with 60% invested in stocks and 40% in bonds and other fixed income investments. For decades, this has been the typical manifestation of portfolio diversification and has benefited at least two generations.
Let’s find out if a simple 60/40 portfolio is still relevant. Since the early 2000s, there have been multiple instances where stock markets have been rocked by recurring pitfalls and at the same time, even infallible fixed income assets have taken away billions.
It seems that a 60/40 portfolio is no longer the wealth creator it used to be, and in fact, even passive index investing can yield more returns than a simple 60/40 portfolio.
Diversification for long-term wealth creation in today’s environment
The main reason for portfolio diversification is to hedge against unpredictable market declines, thereby minimizing the risk of losing invested capital.
Right now, bonds and stocks are not enough to represent long-term wealth creation in a sustainable way. A simple 60/40 portfolio is no longer a hedge against market uncertainties and does not seem to keep up with the current market environment and investor appetite.
Alex Shahidi, a professor at California Lutheran University, in his article “Why a 60/40 Portfolio Isn’t Diversified”, demonstrates quantitatively how a typical 60/40 portfolio is now as risky as a pure equity portfolio in the late 1920s.
Traditionally, a 60/40 portfolio has been the preferred choice of investment advisers, but now even their calculations have swung to high-rewarding alternative investments.
Alternative investments are known to offer higher returns than traditional fixed income assets and, at the same time, they are known to quell volatility in traditional markets. These asset classes have long been reserved for ultra-high net worth individuals, but now, with the fintech revolution, things are opening up to investors of all sizes.
Conventional portfolios and the volatilities of modern markets
Analysis suggests that compared to the 1950s and 1960s, the 2000s were wild in terms of market volatility. In fact, the 2000s saw day-to-day volatilities right after the Great Depression.
Between 2000 and 2010, two major bubbles burst in US stock markets, which had a ripple effect on markets around the world. It took years after the following falls for the markets to recover and reach new highs.
Classic portfolios are not very convincing in the face of volatility.
For stock markets, of course, a volatile market would mean a stagnant or slowly growing portfolio over the long term.
The recent example of the post-Covid recovery and resulting market crash is an example of how investors have been stuck with hidden portfolio returns for nearly a year.
Bonds, which are meant to buffer the uncertainty and risk of investing in stocks, are also failing to perform in the light of wild swings in interest rates.
Duration risk or bond interest rate risk refers to the sensitivity of a bond’s price to changes in interest rates. For example, a typical long-duration bond may fall about 5% in response to a 1% increase in prevailing interest rates.
The volatility of stock markets coupled with the interest rate risks of bonds makes a simple 60/40 portfolio ineffective when it comes to building long-term wealth.
Alternative Portfolios: Today’s Diversification
Simply put, alternative assets are investment assets that break outside the boundaries of traditional asset classes like stocks and bonds.
These asset classes are generally known for their lack of correlation with traditional markets and their sustainable returns.
Traditionally, alternative investments have been limited to high net worth individuals due to their high ticket sizes and lack of information and awareness. However, things are changing for the better and online alternative investment platforms are now democratizing these assets for average investors.
Some typical examples of alternative investments can be private equity, venture capital, investing in farmland, real estate, commodities, and the regulated P2P lending ecosystem.
An alternative portfolio is a strategically balanced portfolio of alternative investments and traditional asset classes, designed to maximize returns while minimizing the risks of conventional investments.
The idea of diversifying portfolios is quite recent, in fact, what seems so fundamental in the art of investing was hardly known before the 1960s. evolved only after World War II and dates back to the Great Depression. A simple 60/40 portfolio remained the face of diversified portfolios for much of the 20th century.
Alternative wallets have emerged in response to modern market environments, particularly after the globalization of business and the technological revolution in the form of the internet and increased connectivity.
These portfolios are typically designed with the needs and aspirations of the investor in mind, and feature a strategic allocation of assets across a mix of different traditional and alternative investments.
An alternative portfolio maintains a gentle balance between high growth and reasonable stability. This way, you can ensure that your portfolio achieves the highest possible returns, while dealing with market uncertainties, which are unfortunately quite common these days.
Alternative Portfolios for Average Indian Investors
Alternative investing is a relatively new concept for the average Indian investor. In fact, the pandemic and the resulting lockdowns can be attributed to the force behind the new found popularity of alternatives.
However, despite their novelty, the future of alternative wallets is quite bright in India. A report by Anand Rathi Wealth suggests that overall investments via Alternative Investment Funds (AIFs) will grow at a CAGR of 25% between 2022 and 2025.
Individual participation in alternative investment portfolios is also expected to grow at an exceptional rate. This is mainly due to fintech platforms democratizing these asset classes for average investors.
P2P lending: a new frontier
As the name suggests, P2P lending involves investors acting as lenders, lending their money directly to individuals and businesses in need of debt financing. This investment model can give you returns of up to 12-18% per annum and is tightly regulated by the RBI with only licensed platforms allowed to operate.
You are probably wondering about the risks associated with P2P lending?
Like all investments, P2P lending can be risky if not done carefully. The risk comes from the luck of the borrowers that your investment funds default.
The opinions expressed above are those of the author.
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