Merriman does not include a specific allocation to gold in our standard portfolios. This article, by Bryan Harris of Dimensional Fund Advisors, discusses why gold has not been an ideal long-term investment. It includes the following key concepts:
Gold has done well since the year 2000 and in the 1970s, and can potentially be a safe haven during times of political and economic stress. However, for the entire period of 1971 – 2011 gold performed worse than the S&P 500, U.S. small-cap stocks and non-U.S. stocks on an inflation-adjusted basis.
From 1980 – 1999, gold experienced a negative return after inflation of -6.5%, vs. strong positive returns for stocks.
While gold has held its value against long-term inflation, there have been extensive periods when gold did worse than inflation. Gold is also much more volatile than inflation, and can add substantial volatility to a portfolio.
Unlike stocks, which are productive assets which generate growing levels of income and dividends over time, gold has no cash flow and costs money to own.
For more detail and some illuminating graphs, please see the article.
Some of our clients occasionally express concern about the situation in Europe. Here’s what our Director of Research, Larry Katz, has to say about Merriman portfolio exposure to those markets:
Europe’s ongoing debt problems have prompted many investors to consider their European exposure, especially to the euro zone’s weaker countries. While there certainly could be global impacts emanating from any area of the world, a major benefit of true global diversification is the controlled direct exposure to the problems of any given geography.
For example, one of our major portfolios is MarketWise Tax-Deferred, a globally diversified, buy-and-hold portfolio with a value and small-cap tilt. Half of the stock exposure of this portfolio is in the United States. The other half is distributed throughout the world.
Of the 50% overseas exposure, as of the end of March 2012 just over 22% was in Europe. Notably, most of that exposure was to the stronger European countries. The top six European countries by exposure (United Kingdom, France, Germany, Switzerland, Sweden and the Netherlands) comprised almost 18% of the total invested in Europe. The weaker countries of Greece, Ireland, Portugal, Spain and Italy totaled only 1.73%.
So a 60/40 stock/bond portfolio had just over 1% exposure to these five troubled countries.
Every portfolio has to incur various risks to generate returns. The key is to intelligently diversify so that, under a variety of market conditions, those risks remain under control.
Please share your view of convertible bonds as an asset class for folks entering retirement.
Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.
We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution. (more…)
I am considering buying bond funds and would welcome your recommendations. I recently read in Time magazine that you could get hurt if you’re invested in a bond fund. How can I get hurt holding bonds?
Many people think bonds are risk free, but that is not actually true. There are multiple risks associated with bonds, but they can be an extremely important component of a portfolio despite those risks. And, if properly allocated, they can provide a level of security above and beyond the equity markets. Of course there is no free lunch, and the added stability of bonds requires a tradeoff. Namely, you are foregoing the equity premium associated with stocks.
We recommend using a mix of high quality short- and intermediate-term government and Treasury issues. For tax-deferred accounts we include Treasury Inflation Protected Securities (TIPS). This allocation is purposefully designed to be very conservative. Nonetheless, it is still subject to certain risks. Interest rate and inflation risk make the top of the list. You can alleviate the risk of inflation through the use of TIPS. Interest rate risk is somewhat of a different story.
There is an inverse relationship between bond prices and interest rates. As rates rise, bond prices fall and as rates fall, bond prices rise. Longer-term bonds are hit hardest in a rising rate environment; short-term issues are hurt the least. Of course shorter-term issues generally pay less interest. If you want an appreciable return – especially in today’s low rate environment – you need to extend beyond extremely short-term debt. Our solution is to limit risk exposure and also gain some additional yield by using high quality short- and intermediate-term US government and Treasury debt.
One of the most important things you can do as an investor is keep your risks under control, and this is one of the most powerful lessons we teach at Merriman.
Our work has lots of fans. Allan Roth, a financial planner and author who teaches behavioral finance at the University of Denver, recently drew on some of our work to make the case that many investors are taking more risk than they realize. You can read his blog post on the topic at CBSMoneyWatch.com.