Whilst portfolio diversification may have gone out of style this past year with US stocks soaring to record highs, it seems as though this tried and tested approach to achieving financial goals may be back in vogue as investors look to mitigate the risks of a third financial bubble in the space of 15 years.
Many financial commentators have described the recent global stock market turmoil as ‘unprecedented’, but the reality is that its evolution has been quite traditional so far.
This selloff began as a repricing of global growth prospects and the increased likelihood of a global slowdown. The spreading fear that policy makers would not be able to respond quickly and effectively caused it to accelerate.
As is often the case, the selloff gained momentum as volatility-sensitive investors realized that their portfolios had become massively over-concentrated in only a few asset classes.
All of the above is typical of a generalized market selloff that, over the short term, will often spread to most all other asset classes as panic and fear sets in.
Strategies for protecting your wealth
Over the past 10 years, most of the per annum return of portfolios came from the valuation tailwinds resulting from declining interest and inflation rates. Today, most portfolio strategies generate a yield of less than 2%.
With stock yields below 1.5% and bond yields of 2.5%, it is simply unreasonable to expect to continue to receive the commonly assumed 7-8% percent returns. Neither the need for a particular rate of return nor the hope for performance that can sustain outsized spending allows us to expect that return. Hope is not a strategy, we need to spend sustainably.
Many of the challenges pensions, endowments, foundations and retirees will be facing in the future will stem from unrealistic return expectations and a desire to spend more than market returns can support.
Sustainable spending is not a fixed rate. It changes as yields change. If we can’t rely on the valuation increases, then portfolio strategies that boast meaningfully higher yields and higher prospective income growth will tend to outperform substantially in the future.
Continual rebalancing across a variety of markets is key to reducing concentration risk and generating returns. Through rebalancing your portfolio to its targeted mix each quarter, you can shift away from popular asset classes when they are overvalued and move into asset classes when valuations are fundamentally attractive.
For those who focus on spending power, market downturns can turn out to be terrific opportunities to rebalance into high-yielding assets, providing the opportunity to increase sustainable spending power.
