Are Pundits Touting the Wrong Sleep at Night Investing Strategy After Recent Market Turmoil?

By Derek Moore

During the recent October 2018 market drawdown, we heard the usual commentary from market professionals who issued their predictable words of wisdom. Things like “it’s important to have cash on the side”, “diversification is key”, or “have a well-balanced portfolio in high quality names you can whether down markets”. 

The bond advice instructed investors to take 100 minus their age to figure out what percentage to put in stocks versus bonds. Meaning, if someone is 50 then they theoretically should have a 50/50 portfolio between stocks and bonds. 

Each of these bits of advice are very generic and each have their own set of issues. First, how much cash should people have considering it earns negative real return after inflation? and for how long? What about how even a diversified portfolio failed during in 2008 as everything seemed to go down all at once?   

Third, often some professionals, well intentioned, point to bonds as historically being a safe place in an investor’s portfolio. After all, for most of history, bonds have paid out a nice risk adjusted return in the form of higher interest payments. But over the most recent decade, since 2008, we have had close to zero interest rates on the short end of the US Government bond curve. With interest rates so low and rising, bonds are susceptible to market value losses should rates rise even modestly. Consider that the ETF: AGG US Aggregate Bond Index is down over 4.5% year to date. If we look back since 1980 we would find that if AGG closed the year where it is today, it would be the largest yearly loss during that time period.So, while bonds may be thought of as your safe space in a portfolio, in this environment they may not return much more above inflation. 

Instead of loading up on bonds or cash, consider a different “help you sleep at night strategy”. Consider hedging.

Regular readers know we like to own the market and hedge the downside. This gives investors the ability to stay in equities but have the goal of putting a downside floor in their portfolio. This is done with the intention of capturing the majority of the upside when stocks go up, without the unprotected risk of market volatility when stocks go down rapidly. 

Next time CNBC breaks in during a market selloff and someone starts giving advice, consider the benefit of using a strategy that mathematically defines risk, and doesn’t count on asset diversification like ZEGA’s ZBIG or Buy and Hedge.