Stick With Your Allocation
Read the weekly bond market commentary from Drew O’Neil
If we all had a crystal ball that allowed us to see exactly what was going to happen in the future, the task of portfolio allocation would be much easier. We could simply invest 100% of our available funds into the asset class that was going to perform the best, sell at exactly the right moment, and then reinvest into the next best performing asset class. The entire challenge of both asset class selection and timing would be removed and investing would be much easier. Unfortunately, seeing into the future proves to be a difficult task.
We are left to rely on forecasters’ predictions as to what they think might happen when considering how to invest. Many of these forecasters are extremely intelligent, have incredibly sophisticated models, very well thought out theories, and powerful computers all working together to give their best guess on how to optimize returns based on what is potentially going to happen in the future. Unfortunately, when it comes down to it, they are still trying to predict the future, which is unknowable, even to the smartest among us. The graph below highlights just how hard predicting the future is. The red lines represent a Philadelphia Fed survey taken at the beginning of every year on the consensus estimates from some of the smartest economic minds in the country, projecting what the 10-year Treasury will do over the next 5 quarters. The blue line represents what the 10-year Treasury actually did.
The graph speaks for itself… predicting the future is very hard to do. So how should we position our portfolios without knowing what is going to happen next? That is where an appropriate asset allocation fits in. Properly splitting up your assets between stocks and bonds (and potentially commodities, real estate or whatever else your analysis deems appropriate) can set you up to hopefully weather any storm. Maintaining an appropriate allocation to fixed income, based on your risk tolerance and goals, is important regardless of what you think is going to happen next, because as the chart above tells us, even though you think you know what is going to happen next, you likely do not.
Where investors can get into trouble is when they allocate money that is earmarked for fixed income to other asset classes, either in a reach for yield and/or total return, or because they are sure that equities are going to outperform over the next 12 months. Fixed income is generally supposed to be the stable portion of the portfolio, providing consistent cash flow, income, and return of principal. It is not intended to provide annual returns of +10% (although sometimes it does), it is intended to be stable and consistent. The numbers below shine some light on why you own fixed income, especially in the face of uncertainty in the economy. Going back 30 years, take a look at the worst years for each of these three asset classes:
A “bad” year in fixed income generally does not hurt near as much as a bad year in equities. No one knows for sure what is going to happen over the next month or year… stick with your allocation. A portfolio of high-quality bonds is typically not intended to make you wealthy, its purpose is to help you maintain the wealth that you have already accumulated.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.