When markets get frothy, make sure you have a balanced portfolio!
By Lawrence A. Sautter, 31st January 2017
As the financial markets generally are unpredictable, it is crucial to have a well diversified portfolio with different assets. In an environment where you have increasing interest rates, high valuations and rising inflation expectations, you could suffer a big capital loss on long-duration bonds and overvalued stocks, but during a recession the fixed income part of an asset allocation could give you the cushion you need for lower volatility and stability within your portfolio.
However, you want to have some kind of an inflation-hedge over time, so you will need some balanced exposure to equities that can grow their earnings and dividends over time. You can stick with Dividend Aristocrats and Dividend Kings with above average Dividend yields and Dividend growth, low payout ratios and low beta as a core holding within your equity exposure.
The Dividend Aristocrats for example (stocks with 25+ years of rising dividends) have outperformed the S&P500 over the last 10 years by 2.88% per year.
Because we do not have a crystal ball, we need a long-term balanced portfolio-solution with bonds, equities and perhaps some alternative investments that do not correlate at all with classical assets. Diversification with some real assets like commodities (Gold and Silver) and real estate could be a further step towards an inflation-hedge. Treasury inflation-protected securities (TIPS) may be an attractive alternative to Treasuries and fixed-income assets tied to real assets such as commodities and/or real estate. Floating-rate loans would be a good alternative to cash.
Low volatility Dividend-stocks with low-payout ratios are especially interesting and contribute to a lower portfolio volatility and offer higher real income. They have produced excellent risk-adjusted returns and historically seen smaller drawdowns during recessions.
So for uncertain times, it is safer to have a balanced portfolio versus a bond portfolio, especially when central banks follow a Zero-Rate or Negative-Rate policy the downside risk for bonds is capital loss and inflation risk looming around the corner.
Just have a look at this portfolio example:
You would have lost more than 9% on 20+ year treasury bonds (TLT) over the last 3 months and -3% over the last 12 months, while the low beta Dividend Portfolio managed to gain 3.9% and 9% over the same period. That’s an awesome outperformance of 13% and 12.2% respectively with a better Sharp Ratio.