In the early days of investing, if someone wanted to make an equity investment, they purchased individual shares of stock, and achieved diversification by purchasing shares of a number of different stocks. Similarly, if an investor wanted exposure to debt, they purchased individual bonds, and achieved diversification through purchasing bonds of various companies, with varying maturities.
Investing Based On Long-Term Averages
For the past 50 years, most advisors have relied on how a particular mix of assets perform over the long haul when making investment decisions. The average “moderate” portfolio is typically a 60/40% mix between stocks and bonds. Regardless of whether markets are underpriced, fairly priced, or overpriced, the portfolio doesn’t vary much. This has typically been supported with the explanation that it’s impossible to know where markets are headed. It was believed “staying the course”, according to the asset allocation model dictated by a client’s risk tolerance, established predictability of returns over the long run. This may have been true in the 1950s when mathematical models could not adequately assess the risks in the market.
As we enter 2014 we see continued stimulus by the FED that is likely to keep interest rates from rising significantly this year. Although many of the risks we faced in recent years are still on the table, we have seen improved employment figures and rising consumer confidence that is creating a more optimistic outlook for 2014.
This is not to say that market risk is low. In fact, most measures of market value point to a market that is poised for at least a modest correction this year. It has been over two years since we have had a 10% market correction, which is normal, healthy, and long overdue.