Today I have been reading a bit on approaches Financial Planners are taking when advising their clients on the ideal asset allocation. I was surprised to learn that most planners are now advising to shift investment strategies towards U.S. equities and bonds have deeply fallen out of favor. In the chart below, you will notice how U.S. equities recently saw a large influx of cash after the elections.
Should you change your asset allocation after the elections?
With the recent turmoil in the American and Global markets, mainly due to the new presidency, people are reconsidering their asset allocation and changing their investment strategy. I was surprised to see that financial planners, the people that are supposed to steer their clients in proper asset allocations and talk them out of reacting to the short-term news, are in fact changing their asset allocations according to short-term news. Planners are now buying more into U.S. equities and ditching the bonds simply on speculation.
You should not change your allocation with news events but rather, according to life events. You should have a set allocation and stick to it until your personal situation changes such as after marriage, kids, or retirement, for example. The most popular reasoning behind the equities and bonds allocation is age but I also disagree with that rational as I previously talked about in a guest post I did over at GenYFinanceGuy.
Advisers sharply increased allocations of client assets to U.S. equities, but some planners are cautioning against piling into a market where they see valuations as being too high. – Andrew Welsch
Advisers say the shifts in asset allocations were motivated by post-election expectations of changes in the tax code that would benefit wealthy Americans, an increase in interest rates and the possibility of new stimulus under President-elect Trump’s proposed infrastructure program. – Andrew Welsch
Over the years, there has been elections cycles, riots, wars, policy changes, but in the end, the market always goes up. If one would change its investment strategy every time something happens in the world, he would be switching something every single day!
As shown in the chart below, that shows the running percentage gain in the Dow Jones Industrial Average by presidential term, there have been some ups and down to the market but little correlation with the election cycle. Going back to Calvin Coolidge, the 30th president of the United States from 1923 to 1929, this graph shows how most presidents saw growth in the markets and all of them saw swings during their terms. This makes sense since, historically, the market has been up 7 out of 10 years on average. They are also all seeing swings because there is no clear equation that equates; this president = markets go this way. Markets are alive and a creature by themselves, the political structure around them might help contain it but, by no means, controls it.
How about global markets?
In addition to a drastic change in the equity/bond allocation, financial planners are also pulling away from the global markets. I would argue that you cannot predict the markets but having investments across the globe, in different asset classes, allows you to always be there when it does go up.
Planners also said they pulled back on global equities for fear of protectionist policies being put in place in the U.S. and other countries. – Andrew Welsch
Historically, the global markets have not always been correlated with the American market and have done very well over the long-term. More than 90% of your total investment return depends on your asset allocation so why only focus on your home country when the economy is now global?
Throughout history, the markets have jumped up and down (mostly up) and consistently been good to long-term investors. The following shows the annualized real returns of equities and bonds across the globe. In addition, the cumulative columns represent the number of times your dollar would have multiplied since 1900. For example, a dollar invested in the American market would have multiplied 1,248 times or to put in perspective, $10,000 would have grown to $12,480,000 over the last century. 🙂
|Annualized real return of Equities||Cumulative since 1900||Annualized real return of Bonds||Cumulative since 1900|
But how about the market capitalizations?
In terms of market caps, which is the total valuation of companies based on their current share price and the total number of outstanding stocks, your allocation should rarely change at all. The ideal portfolio for index investors would be to have the exact allocation present in the total market. For example, your small-cap holdings should represent roughly 6% of your portfolio (6.69% as of date of posting) and so on. The easiest way to achieve this is to invest in a fund like the Vanguard Total Stock Market ETF (VTI) for the U.S. or the Vanguard Total World Stock ETF (VT) for a global exposure that includes all market caps.
Following this structure, your portfolio would not change according to age nor to life events. Your exposure to market capitalization should stay pretty constant and simply follow the current breakdown. Below, you can watch a short video from Vanguard explaining the rationale behind this allocation.