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This Common Strategy Could Be Quietly Ruining Your Portfolio

Wednesday, April 26, 2017 4:35

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For decades, financial advisers have recommended putting 60% of your money in stocks and 40% in bonds. The conventional wisdom is that the safety and stability of bonds will protect you when stock prices fall.

Too many people believe stock and bond returns correlate negatively, meaning they reliably move in opposite directions.

But taking this tired advice could ruin you…

Christopher Cole at Artemis Capital Management – a hedge fund that specializes in volatility investing – busted the Wall Street “60/40 stock/bond” myth in an October 2015 research report called “Volatility and the Allegory of the Prisoner’s Dilemma.”

Cole looked at more than 132 years of data and discovered the correlation myth is false.

He writes, “The truth about the historical relationship between stocks and bonds is scary…”

Using data from 1885 through 2015, Artemis discovered that stock and bond prices have historically moved in the same direction roughly 70% of the time.

According to Artemis, it’s only during the last two decades of falling interest rates and accommodative monetary policy that stocks and bonds have been negatively correlated. Otherwise, the firm reports, “Not only are stocks and bonds positively correlated most of the time, but also there is a precedent for multiyear periods whereby both have declined.“

This might seem like a purely academic topic. Even Artemis admits the last 20 years have been pretty good, with bonds protecting investors when stocks sank.

But that’s exactly the type of thinking that had investors in the early 2000s repeating, “Housing prices have never experienced an annual decline” – right up until the housing bubble blew up.

Nobody has any excuse for believing stock and bond prices can’t fall at the same time… because that’s what has happened 70% of the time going all the way back to 1885.

Artemis reports, “In the event stocks and bonds simultaneously lose value, the classic 60/40 will become a 100% loser...”

This kind of allocation can be particularly risky when the markets have been calm for a while…

The Volatility Index (“VIX”) – the market’s “fear gauge” – currently sits around 11.

That’s historically low. And it suggests investors are incredibly complacent right now.

Meanwhile, since President Trump won the election, the S&P 500 has marched roughly 11% higher and is now trading around 25 times earnings.

The more expensive the market, the riskier it is. The lower the VIX, the less fear there is in the market. When both happen at the same time, like today, that’s a bad combination…

When volatility stays low, the stock market road is smooth. But when the stock market finally hits its next bump in the road, volatility could soar higher than it typically would in a more volatile environment.

So it’s prudent to prepare yourself for higher volatility. But don’t count on the 60/40 stock/bond allocation to protect your portfolio…

For most investors, the best approach is to keep plenty of cash on hand.

Not only will that protect you from a market pullback, but it will also let you take advantage of bargains that pop up when the market falls and volatility soars.

The best, easiest, lowest-cost way to protect yourself from big drawdowns is to hold plenty of cash.

Let me be clear… I do not recommend selling all your stocks and going 100% to cash. That type of extreme approach guarantees you’ll miss out on the compounding that has ruled the stock market for more than a century now.

It’s simply far, far better to hold some cash and keep your capital safe than to watch your portfolio dwindle if the market suffers a correction.

Good investing,

Dan Ferris

Editor’s note: Dan’s strategy is to buy great businesses “on sale,” then sit back and collect huge gains – without worrying about market events. His latest recommendation is a cash-gushing business ready to not only weather big changes in its industry, but prosper. Dan believes shares could rise as high as 50% over the next year alone. You can try his research risk-free – and learn how to access this recommendation – by clicking here.

Source: http://www.stansberryresearch.com/dailywealth/3528/this-common-strategy-could-be-quietly-ruining-your-portfolio

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