Monday, October 17, 2011

Great Article on the Risks of a 60/40 Portfolio But Adding Commodities is Not the Answer

'Buy-and-hope' is not good enough

The author of this article rightly points out the main problem with the typical 60% stock/40% bond portfolio. Stocks are much more volatile than bonds so you could have a period (like 2008) where stocks go down a lot and bonds go up a little. The bonds help some but the investor is still subjected to large, unacceptable losses. The solution the author proposes is to add commodities to the mix. This doesn't really help much and it can hurt. Commodities are more volatile than stocks at times. Adding them to a portfolio shifts the dominance away from the stocks more towards the commodities. That is fine if commodities are always uncorrelated with stocks, but they are not.

The real solution is to not get caught up in fixed allocations. There is no reason to have a 60/40 mix when stocks are in a downturn, the investor is taking way too much risk. On the other hand, when stocks are in an uptrend having 40% in bonds can be a real drag on returns. Market dynamics should always determine allocations.

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