Adding Alternative Investments to a Stock/Bond Portfolio
by Phil DeMuth and Charles Rotblut, CFA
Phil DeMuth is a registered investment advisor with Conservative Wealth Management LLC and co-author with Ben Stein of “The Little Book of Alternative Investments” (John Wiley & Sons, 2011). I recently spoke with Phil about ways investors can expand their portfolios beyond stocks and bonds.
Charles Rotblut, CFA
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Charles Rotblut (CR): In your book, you argue that the traditional allocation of 60% stocks and 40% bonds has some weaknesses. Can you briefly explain why you think that and what some of those weaknesses are?
Phil DeMuth (PD): While there’s a great deal to love about the classic 60/40 stock/bond portfolio, the principal downside we see with it is that really, almost all of the volatility comes from the stock side. Depending on what your starting and ending points are, anywhere from 85%–95% of the day-to-day fluctuations of the portfolio comes from stocks. And that means that a bad year for stocks is going to be bad for this portfolio, pretty much no matter how the bond market does. The bond market is almost irrelevant. It acts, for better or worse, like a stock portfolio. And with that comes the big problem, which is that when bad times hit, investor’s portfolios are down, and it’s typically a bad time for the economy in general: People’s jobs are looking tenuous, their spouses’ jobs are looking tenuous, credit is hard to come by, the value of their house is down—the roof all falls in at the same time.
This gave us the impetus to look for alternative investments that might provide a cushion, or have at least an alternative series of returns than we would get just from the stock side. Another way of saying this is: “2008.” The year 2008 really showcased the limitations of equities and of traditional ways of trying to diversify. We were trying to see what else is out there that might have helped. That brought us to alternatives.
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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.
Discussion
So generic That many have read it a dozen times.
Get specific, put yourself on the line today.
hcf
posted about 1 year ago by Henry from Alabama
BIG DEAL - So you move out of stocks bonds by a total of 12% and into other things. So if those things go up when everything tanks - GOOD - but as you say that does not always happen - AND we're only playing with 12% - can't make that much difference.
posted about 1 year ago by H. wesley from Pennsylvania
Note: Most MLPs are going to be in the Energy Sector; most Reits fall into the Financial Sector though they may have an emphasis on Healthcare or other sectors. One must ask, "How do these assets fit into my sector allocation?"
I am 12% in REITs and 12% in MLPs. These are conservative low beta players with an average yield of about 5.5%.
Overall I am 60%/40% with a core of Blue chips (ABT, PB, KMB, T, JNJ, etc.)
The author's tiny allocation in these alternatives borders on meaningless IMHO. In my portfolio we're talking about more than a token investment and a meaningful boost to overall portfolio yield.
I am retired and this income keeps me eating.
posted about 1 year ago by Robert from Florida
Ben Stein sings the praises of Phil Demuth. Every time Mr Stein speaks about his personal investments he gives credit to Mr Demuth for the ideas.
I am not sure what Mr. Demuth espouses in this interview amounts to very much protection. Many so-called investment experts suggest an even greater allocation to fixed income as one gets into his (her) retirement years. Perhaps an individual investor has to become educated in the field of investing and don't try to follow the crowd---but do his own thing for only the individual knows what is best for his given set of circumstances.
posted about 1 year ago by Vincent from Connecticut
REIT common shares are not particularly cheap today, and were a disasterous holding in the 2008 downturn. A strategy that has worked for me is to buy preferred shares of specialty REITs in health care and mini-storage. Recently hotel/motel and logistics are looking better, too. I look for REITs where the underlying buisnees is improving, and the board has just restored or just boosted the dividend on their common shares. I have found many preferreds selling at a discount to their call price. Many will yield in the 6-8% range. The price of these shares has held up well in spite of recent weak economic numbers and jitters about Greece.
posted about 1 year ago by Joseph from Minnesota
I am curious: why no mention of the rather extraodrinary yields in REITS such as Annaly?
posted about 1 year ago by Patricia from North Carolina
What AAII needs to do as get Terrance O'Dean to write a few articles.
Here's his personal website:
http://faculty.haas.berkeley.edu/odean/
posted about 1 year ago by Lester from Texas
Seemed like a rehash of a lot of other comment of late, without adding anything new. As an alternative, how about using TA to evaluate sector or industry group behavior ihn each of the last two major market cycles. It doesn't take a lot of effort to see which sectors were affected and when, in each cycle. That's much more informative and relevant to the issue of smart diversification. I'm certainly not impressed by excuses of why a given approach/result was atypical during our present cycle.
posted about 1 year ago by Lou from Ohio
Is there truth in the saying, "I can't afford not to be risky"? Outliving a nest egg is the rudimentary quagmire many face. Why not bolster the 3% allocations mentioned?
posted about 1 year ago by Richard from Tennessee
What the individual investor needs is confidence in the market. Without meaningful regulations of the finance/banking market we throw darts at a target we cannot see.
Or, we could repeat the recent financial collapst.
Or we could incur more national debt.
Or we could raise revenue (taxes) to get out of the financial hole we are in.
Congress needs to take responsibility for spending without increasing revenue. How about emergency legislation to repeal the Bush tax cuts? That would not effect about 98% of us.
Please pay attention what the politicians are doing to us! Surviving retirement when assets disappear is tough.
posted about 1 year ago by LOUISE from Florida
On page 1 of the article, Phil Demuth makes the statement, "Historically, lower-beta portfolios have tended to return about the same as higher-beta portfolios.
I find this to be an extraordinary claim. I cannot say that Mr. Demuth and has investment company have not been able to achieve such results with excellent stock / bond picking tactics, but I can’t see how the statement applies to portfolios made up of mutual funds and ETFs.
Why? First, in general, it is inconsistent with the near-consensus acceptance of the investing principle that riskier investments produce higher returns.
Second, with somewhat more detail, consider the standard 3 pronged asset allocation plans commonly offered / recommended by large financial institutions and prudent financial advisors: They say allocate your money amongst the stock market, the bond market, and the money market. - - - Analyses of the long term history have shown that the stock market returns 9%-11% per year (depending on which analysis you read), the bond market 6%-8%, and the money market 4%-5%. So, clearly, the way to maximize your returns over the long run is to invest 100% of your money in the stock market.
Of course, there is a downside to that strategy, it produces the highest volatility (beta) in your portfolio value. You can reduce that volatility (beta) by moving some of your funds into the bond market or the money. There is general consensus in the investment community that bonds have lower volatility than stocks and the money market even lower.
However, as soon as you move one dollar from the stock market to either the bond or money market, you will reduce your long term returns. (I think this would be clear, even to those people who are math-averse.)
So, I challenge Mr. Demuth to come forth with a specific asset allocation portfolio that we average investors could have used over the last few decades that would have produced the same return as a portfolio fully invested in the stock market, but have lower volatility (beta).
If he is able to do so, I will be the first one to stand up and applaud him as I am always looking for such a strategy.
Jim Grant
Solon, Ohio
JWGrant@AOL.com
posted about 1 year ago by James from Ohio
I am an investor in MLPs....PD gave the typical answer that I get (and got) when I asked my financial advisor and broker on their opinion of MLPs.....I fired both on advice of my CPA/tax preparer and went to a discount broker who offers GREAT 1099's for the IRS and did my own investigating......if you can't any answer to a MLP question, contact Mary Lyman, Exec. Director of the National Assoc. of Publicly traded Partnerships OR better still, attend the upcomiing AAII conference in Las Vegas in Nov........great issue of your Journal....bill dunn, Prescott, AZ
posted about 1 year ago by B. William Dunn from Arizona
I am an investor in MLPs....PD gave the typical answer that I get (and got) when I asked my financial advisor and broker on their opinion of MLPs.....I fired both on advice of my CPA/tax preparer and went to a discount broker who offers GREAT 1099's for the IRS and did my own investigating......if you can't any answer to a MLP question, contact Mary Lyman, Exec. Director of the National Assoc. of Publicly traded Partnerships OR better still, attend the upcomiing AAII conference in Las Vegas in Nov........great issue of your Journal....bill dunn, Prescott, AZ
posted about 1 year ago by B. william from Arizona
Some of the readers are brilliant!
Perhaps you have chosen the wrong people to highlight in your publication.
posted about 1 year ago by Curt from Florida
It's hard to see how 12% divided into 3 components can add either stability or much in the way of increased performance with less risk to a portfolio that is still 51% stocks and 37% bonds.
posted about 1 year ago by Thomas from California
Disappointed in the Q&A with PD. I learned a few facts but nothing that is going to change my current strategies. Too much "verbal hedging".
Ahh, but! -the reader comments-got me thinking and reacting !! Thanks, all.
Bill, New York
posted about 1 year ago by William from New York
A lot of verbiage but not much light. So general it is almost meaningless. I have been reading the same "advice" in dozens of other places since 2008. Nothing concrete here. I agree with the comments about MLPs and outstanding REITs (Annaly or Coresite anyone, as has been suggested). And if the return of hedge funds is between stocks and bonds, why bother particularly with their expenses. As has been pointed out, 12% divided in three sectors is hardly a big deal. How about interviewing someone putting their suggestions on the line. The comments are the stars of this article.
posted about 1 year ago by Richard from California
When I think of alternative investments, I think of hobby items or art work. I have bought a few cars that were unappreciated at the time, but I had a passion for them. I liked what I liked, and let the rest of the world be damned. The best investment of them all was a purchase in 1963 for about $1000. Based upon written, recent, unsolicited offers, appreciation has been just over 18% per year, compounded. I assume this can't go on forever, but I've been assuming that for at least 20 years, yet that 18% still seems to hang in there. So my advice, if one has a passion, go for it. "They" may come around to see it your way.
posted about 1 year ago by David from New York
Hi, .The best asset allocation I have found in my 35 years of research is Harry Browne's "Permanent Portfolio" you can find info when you google "Permanent Portfolio" I've been really disappointed with the quality of the mutual fund and portfolio advice in the last three months of AAII Journal...Anyway..if you guys/gals want to make some money, protect your money and sleep at night check out Harry Browne's books,, Also, there is a mutual fund called "Permanent Portfolio" It has a different allocation then the one Harry finally ended up with at the end of his career(he's passed) But it was his thinking at the time when it was put together...but it has returned 10% per year for the last 10 (YES 10) years..you will not find any poplar allocation in any main streeam publication or AAII model portfolio that will be even close to that annual return....Farewell fellow investors.. be independent..Vincent
posted about 1 year ago by Vincent from North Carolina
Good grief - AAII is recycling these "features." I see my 6 months old comments above.
Most asset classes are highly correlated now because there is too much debt risk in the global financial system. The retail investor just gets hammered by the algorithm-driven, off-exchange dark pools and the big money ping-pong-ing between risk-on / risk-off trades.
The sort of "alternative investments" strategy outlined here is not going to be effective in preventing volatility in the portfolio of the average investor.
The thing about these alternatives is that you need to do a lot more research to understand what you are getting. And like all investments - if you don't understand it - don't invest in it.
If anything, adding commodities, especially in the form of rolling futures contracts is likely to add volatility. REITS - what kind?
Hedge Funds? There are a dozen strategies a bad choice could really hurt.
Better to hold an additional 12% cash and wait for a bargain to present itself.
posted about 1 year ago by Joseph from Minnesota
