Investors will do well with ‘foundation’ portfolio even in a Year of the Dragon
In ‘Year of the Dragon’, investors must recalibrate their holdings with a mix
A New Year is always a time to reflect on the previous year, what we might learn from it and then apply these learnings going forward.
What better time for reflection than now, as we usher in the ‘Year of the Dragon’, considered one of the most auspicious creatures in the Chinese zodiac. The mythical dragon symbolises power, wisdom, strength, and good fortune.
From an investment perspective, however, there is more you can do than wait to tap on the dragon’s luck. Last year, I wrote that in investing, it is just as important to follow some key principles, such as diversifying and keeping your emotions in check, as it is trying to predict what the future holds.
Investors will benefit from allocating a sizeable portion of their wealth into a ‘foundation’ portfolio, consisting of diversified stocks, bonds, and other alternative assets invested for the long run, and opportunistic trades, which are more short-term in nature. We call the former a foundation portfolio because staying invested in such a portfolio and rebalancing periodically to bring it back to a target allocation (thus automatically ‘selling high and buying low’) has historically helped seasoned investors beat cash returns and inflation over the long run.
Following this core principle helps an investor stay disciplined, rather than relying too much on trying to time the market.
Awaiting a recession
Last year provided a powerful illustration of the benefits of this approach. At the beginning of 2023, almost everybody was on alert for a recession in the US and worried about what that would mean for the performance of equity markets around the world. This led to people rushing to the safety of cash deposits, as they waited for interest rates and bond yields to peak and for the recession to pass.
One year on, we are still waiting for a recession and bond yields peaked much later than expected, although once they did, they dropped dramatically in Q4.
Those guided exclusively by trying to time the market or put too much of their wealth in higher yielding deposits did much worse than those who maintained a diversified foundation portfolio. For instance, our CIO Signature investment strategies which adopt a diversified approach delivered healthy returns in 2023.
Our growth strategy, with a higher weight to equities than bonds, rose over 13 per cent; our balanced strategy was up over 11 per cent; and our Income generating strategy was up almost 9 per cent. Those are better-than-average annual returns generated over the past century…
Of course, the path was not a straight line. The more volatile growth strategy fell over 9 per cent peak to trough during the year. However, experienced investors targeting to grow their wealth over the long run would know that any significant decline in a diversified foundation allocation is a buying opportunity.
The deposit downside
For sure, cash deposits still look attractive today, given close to 5 per cent yields on offer on USD short-term treasury notes. What is often ignored by many investors is the so-called ‘re-investment risk’.
Think of what would happen to those deposits when they mature in a year’s time. Interest rates available a year from now are likely to be lower, perhaps much lower, than where they are today. Investors would have to then park their matured deposits at the lower interest rates.
If an investor is really worried about the investment outlook because of a recession over the next 6-12 months, a more fruitful way to park her savings would likely be in a foundation portfolio adopting a relatively conservative asset allocation strategy. Such a strategy would have a larger allocation to a mix of government and corporate bonds than stocks.
This strategy is not only likely to provide income close to the current cash deposit rates, but it would also offer the potential to provide additional returns as yields on government bonds decline (and therefore bond prices rise) in the event of a recession.
Another key benefit from such a strategy is that it would provide investors with the opportunity to still benefit from any upside in equities, should the recession be delayed by yet another year.
In the Year of the Dragon, this is the lesson I think last year taught us: start with a foundation allocation that suits your risk appetite and financial needs, and then add to this on a regular basis, accelerating investments should the performance deteriorate. Follow up with opportunistic investments if you want to, but only after a foundation portfolio is in place.
If you follow this time-tested principle, you will thank yourself, and not just the lucky dragon, for your good fortune.