It’s no doubt been a painful year for investors thus far. Both U.S. and non-U.S. equities are down broadly, with technology and growth stocks currently in bear market territory. Fixed income, typically a powerful diversifier in down equity markets, has fared little better. All while inflation and the war in Europe show little sign of ending anytime soon.
With markets delivering negative returns YTD to investors, it’s perhaps natural for investors to begin second guessing their asset allocations. However, the question we should be asking ourselves isn’t whether we should’ve done something differently in the past, but how best to go about making decisions in the future.
With most asset classes down across the board, it’s right about now when the financial press begins parroting articles about “alternative” investments for outperforming in bad markets—all of which prompts investors to begin engaging in “what if…?” thought exercises regarding their portfolio. What if we had an allocation to Treasury Inflation-Protected Securities (TIPS)? What if we held more real estate? What if we moved into gold, commodities, or Bitcoin at the start of the year and “side-stepped” these losses? That’s five “alternative” asset classes that are often touted as non-correlated or inflation-hedging assets.
But thinking there are “obvious” sure bets to combat market corrections or inflation is little more than myth. TIPS, for example—a favorite among inflation-haters everywhere—are down 6.64% YTD, similar to that of a short-duration, nominal bond portfolio. What about real estate? It’s down 13.54%, about the same as equities. What about Bitcoin and its supposed non-correlative and anti-inflationary properties? It’s down the most of our list of alternative asset classes: -27.8% YTD as of Friday’s close.
Okay, what about the classics—gold and commodities? Both are up YTD, 5.8% and 31.6% respectively. Finally, we have a winner! Two actually. Maybe 2 out of 5 (40%) isn’t bad. So, what are we waiting for? But wait, there’s more.
Any thought exercise of this sort requires a series of questionable assumptions. For example, let’s assume we did want to add commodities to our portfolio. Before we do so, there’s a lot we need to figure out. For starters, the timing. When do we buy? When do we sell? How do we make such decisions? What do we buy? All, some, one, or none? Would we’ve added commodities in March 2020 or April 2020 when it was “obvious” that easy monetary policy would fuel inflation in coming years—and when the front month oil future contract was trading at a negative $37.63 a barrel?
I put “obvious” in quotes above because—despite what the Fed critics, gold bugs, and commodities bulls would have us think—these things are far from obvious in the real world. For example, the Federal Reserve printed over $4 trillion from 2008 to 2015 and took interest rates to near zero, all pretty much without a hint of inflation. And during that time, let’s say January 2009 to March 2020, commodities lost a staggering 45.25% of their value (a return of -5.21% annually). So, let’s try this again. Would we’ve honestly added such an asset class to our portfolio in March 2020? If we’re like most investors, we didn’t.
But let’s assume you’re one of the few brave souls who did decide to invest in commodities in March 2020. Fair enough. How then would you go about determining how much to allocate to it? 5% or 50%? Why not 100%? At least for your portfolio and financial plan, these are big life and death questions. Size the position too small and it doesn’t have the intended impact; size it too big and you risk destroying a lifetime of hard work and dreams.
We should also keep in mind that all investment decisions involve opportunity costs; for example, a decision to allocate 5% to commodities is a decision not to allocate that same 5% elsewhere. Taking 5% from say, U.S. stocks, to fund a commodities allocation can involve substantial opportunity costs, especially since commodities have lower expected returns than equities. For the 20-year period from April 30, 2003-April 30, 2022, the Bloomberg Commodities Index returned a paltry 0.75% annually versus 10.53% for U.S. stocks, representing a very real opportunity cost of 9.78% per year over that time.1 The question, ultimately, is whether we should reasonably expect the returns on commodities going forward to be higher than those of equities—and, if so, why exactly we should expect this to be the case, especially when history tells a very different story.
Despite a deluge of Quantitative Easing (“QE”) since the financial crisis, this is what the world looked like to commodities investors in early April 2020. Would you’ve invested?
These are already tough times for investors. There’s little point in making them tougher by beating ourselves up and playing Monday morning quarterback. The question isn’t what we should’ve done differently in the past, but how best to go about making decisions going forward. Should we abandon diversification and instead make highly concentrated bets on commodities contracts? Or perhaps engage in market timing or invest in untested, unregulated markets like crypto?
As fiduciaries, we think there’s a better way. One that’s guided by academic research, real-world evidence, and the power, clarity, and security that can come with a comprehensive financial plan. Our approach to investing—a diversified, factor-tilted, market-based approach that diversifies across and within assets classes—doesn’t rely on expensive, esoteric products or the clairvoyance of gurus or celebrity money managers to time markets or make big, concentrated bets on companies, sectors, or asset classes. Sure, there are no guarantees and there will be bumps along the way, but the same could easily be said for any investment strategy. The difference between our approach and other investment strategies is that our investment approach is data-driven and low cost, grounded in prudence and humility, and, has withstood the test of time.
Your advisor is always available to speak with you should you have any questions regarding your financial plan, risk tolerance, or just to check-in on things. Please feel free to contact your advisor at any time. Also, be sure to check out our Insights page for educational content and market updates.
1 YCharts. US stocks is the Russell 3000 Index.
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