The old asset allocation game may be in for some hiccups this season, if some comments by recent guests on CNBC are any indication.
What's the asset allocation game? That's the exercise all investors…especially mom and pop investors…should go through a couple of times a year. If you are not doing it, shame on you.
The Exercise: You take all your investments and consider what broad category they fall into. For most people that would be stocks or bonds. Sure, real estate and commodities can creep into the equation as well. But the big categories for most investors are stocks and bonds.
Then consider where you are in life. As a general rule the older you are, the more you want in "safe" assets. Why? Because if your investments go sour, you don't have a whole lot of career time to make up for it.
Historically the bond category is considered safer than stocks. They typically generate steady returns and are based on underlying debt commitments rather than the sometimes fickle market and asset valuations behind stocks. And so as an investor grows older, the strategy has generally been to move a higher percentage of his or hers overall investments into the bond category.
Indeed there's a rule of thumb, sometimes debated, suggesting the percentage of one's overall bond investments should equal your age, plus or minus a few percentage points for your individual risk tolerance.
But since the Financial Crisis of 2008 investors, spooked by market downturns, the flash crash, and credit crises, have piled into bonds as an alternative to gyrating equities. Probably more than they should, some are warning.
"People have basically said, post 2008, 'I'm afraid of stocks, I'll go into the secure investment', which is bonds," said Jonathan Baum, CEO of BNY Mellon Dreyfus, on CNBC's "Squawk Box." "The problem with that scenario is that we're at the end of a 30-year secular decline in interest rates. So at some point, (interest rates) go the other direction and that's not a good scenario."
When interest rates go up, bonds lose value. And with interest rates at so low for so long, some think they are due for an upward bounce soon.
"The bond market isn't going to fall apart anytime soon, but we're in the foothills of a transition from a bull to a bear market in the price of bonds," said Harry Clark of Clark Capital Management in an interview on CNBC Wednesday.
"Bonds are difficult right now," added James Weddle, Edward Jones CEO, in a separate interview on CNBC. "Medium to short maturities, you're giving up an awful lot in the way of any yield that might be available. But there's a tremendous risk to the principal value when rates go back up."
So perhaps investors need to take a little more care about how much of their investments may be in bonds.
"Here's the big issue," said Baum. "Americans need to retire. Seventy-five percent of them have already said they don't have enough money. Forty percent said they'll never have enough money. So they're funding their long term liability which is retirement in 15 years. On average they're 58 years old and retiring in their 70s, and they're funding it with a security that's at the end of its peak cycle. So you're getting zero real rate of return and you're saying I'll fund the liability by an investment that I'm guaranteed to lose money in. The world's more complicated. It's not 50/50 stocks and bonds."
Which makes the asset allocation exercise a little trickier. Investors not only need to consider the broad categories of investment they are in, stocks vs. bonds, but also the strata of investments within those broad categories. From large caps to small caps in their equity holdings to corporates and Treasurys in your bond holdings.
"Bonds are not inherently a bad investment and we don't advocate you get out of bonds, but balance doesn't mean you move 100 percent to a bond portfolio," said Baum. "The big problem people have is they think it's a binary switch. I go from stocks to bonds. Maybe risky people and speculators do that. But it means I need to start to lessen my bond position, become more balanced. Buy global bonds, buy good U.S. companies and foreign companies, take advantage of the emerging markets."
Of course, figuring out which global markets are promising and what companies are likely to do well presents challenges as well. But at least knowing how much you have in bonds and how much you have in stocks is a good start. (Asset allocation calculator)