Chart of the week
Free Lunch
What does this chart show?
A mix of diverse asset classes outperformed global stocks and a 60/40 portfolio from 2000 - 2022. Global stocks were the laggard over the full period and had no return from 2000 - 2010, a lost decade.
Note - The Treasuries and TIPS are both long duration (20+ and 15+ years respectively), the Commodity Producers represent the S&P Global Natural Resources Index, and Global Equities represent the MSCI World Index. The data in the chart ends in September 2022.
Why does it matter?
There is a line of reasoning that suggests that young people, call it 20-35 year old’s or so, should invest entirely in stocks because they have a long time horizon, many working years ahead of them, and the ability to take more risk. There is a lot of truth in that reasoning. Stocks have had tremendous real performance throughout history. U.S stocks and the world stock market ex-U.S have posted a 6.4% and 4.3% annualized real return since 19001, respectively.
But the reasoning is flawed. The first place this reasoning goes wrong is that it neglects the foundation of portfolio construction, the holy grail - combining assets with low correlation to each other improves return and reduces risk. Even for investors that’ve internalized the power of stocks over long horizons, they may have to wait for over 22 years for stocks to outperform other diversifying assets (gold!?).
The reasoning also overlooks what is perhaps the biggest risk to investors, though, our propensity for self-sabotaging behavior, mostly driven by fear. For example, U.S stocks, which posted a return of 5.9% over the period in the chart, also suffered a real drawdown of over 50% during it. Zooming out back to 1900 shows that U.S stocks have suffered real drawdowns as bad as ~80% once, and have been cut down by over 40% seven other times2. A portfolio that includes diversifying assets helps an investor survive these brutal periods without bailing at the wrong time out of fear.
So while younger investors allocating entirely to stocks makes sense on paper, it should come with a warning label: Your face may be ripped off in this journey. You’re likely to see your investments cut in half at some point during the ride. It will be emotionally challenging. Be ready to hold on.
The Bottom Line
Diversification remains the one free lunch in investing, but it can be hard to stomach during periods when stocks are the only game in town. As Mike Philbrick says, real diversification means that you own some things that are killing it, and some things that are killing you.
Chart & Data Sources - Alex Shahidi and Damien Bisserier, Evoke Advisors
