Global Asset Allocation Confusion

One of the widely held beliefs of investing is that stocks outperform bonds.  Many calculators and financial planning tools automatically give a long-term rate of return advantage to stocks of around 3% per year.  These same calculators or advisors generally steer a person (depending on their age and risk profile) to an allocation that is something like 50% US stocks, 15% foreign stocks, 30% bonds, and maybe 5% other like REIT’s or gold. Does this allocation make sense, for say someone in their mid 30′s?  What would a “neutral” allocation look like.  Interestingly, it seems that the typical allocation fails to consider actual data.

–Stocks versus bonds — In a fascinating article, Bob Arnott looked at returns from stocks versus bonds over very long blocks of time (a persons realistic investment horizon) with data that goes back to 1803.  Interestingly, there were many long blocks of time when bonds outperformed stocks.  For example, in the 41-yera period from 1968-2009, bonds outperformed.  And this is before adjusting for risk.  Simply saying if you invested a block of money in 1968 in bonds, or the same amount in stocks, which would have higher returns by 2009.

–US versus foreign allocation — most market indices (such as S&P 500, MSCI) tend to weight their holdings by market capitalization, meaning that if you were to hold an index fund, you held roughly the same proportion as the amount of shares outstanding.  One of the most curious things in asset allocation, is the lack of revision of most financial planners to the fact that the US has declined in its totalshare of GDP.  A neutral weight in a global index is roughly 60% foreign stocks and 40% US stocks.  How many investors (in the US) do you know who have over half their stocks in non-US stocks?

–Other Asset Classes–one of the challenges of deciding on asset allocations outside of the main stocks, bonds, and cash areas, is the lack of long-term data available.  However, increasingly many people are looking at assets such as commodity related investments to round out their portfolios and provide diversification.

What’s an individual investor to do?  The main thing I would recommend is to re-examine investment advice, re-look at allocation to US stocks (particularly main US-large cap stocks).  While I am not encouraging knee-jerk asset allocation moves, I do think the underperformance (and decline of market share) of US stocks needs to get some attention.  For me, I have had a heavy allocation in global stocks, including emerging markets, but I am less overweight than I thought.  In addition, I am looking to add to my TIPS positions and researching commodity related ETFs.

shared at this week’s Carnival of Personal Finance