Only investing in stocks is like only ever eating tomato pasta for dinner. It’s good, sure, but there’s a whole world of tantalizing options that could make your portfolio much more appetizing. That’s what multi-asset investing is all about: using the full power of all your ingredients – namely bonds, commodities, real estate, or alternative assets – to craft a portfolio that suits your tastes.
Stocks are ownership shares in publicly listed companies. When the economy’s growing, the combination of rising corporate profit and positive investor sentiment pushes stock prices higher. And since the economy tends to grow over time, stocks do too. In fact, they’ve historically been among the best-performing asset classes over the long term.
However, stocks can fall heavily from time to time. High inflation and interest rates can slow the economy down, which sours investor sentiment. And when investors all run for the exit at the same time, stock prices often fall much faster than they rose. So while it’s true that stocks are one of the best asset classes you can own over the long term, they’re still risky due to their major exposure to economic shocks.
Bonds are loans mainly issued by companies and governments. Bonds generally pay their owners in regular coupons, so they offer a steady source of income. Their yield – the return you’d get – is determined when a bond’s first auctioned based on current interest rates, so if interest rates fall, newly issued bonds will pay a lower yield. That then makes older bonds more attractive, and their prices will rise as investors flock to buy them.
Bonds can help protect you during an economic slowdown – and, in turn, a falling stock market – for two reasons. For one, their coupons provide a nice buffer against losses. And for another, bond prices will likely rise if an economic slowdown results in lower interest rates, which are often used by central banks to encourage spending. Inversely, though, rising interest rates are a risk to bond prices, as is high inflation since it diminishes the real purchasing power of the cash that bonds pay.
Bonds have historically generated lower returns than stocks, it’s true, but they’ve also been less risky. And if you adjust for that risk, bonds have actually beaten stocks over time.
Commodities are raw materials and agricultural products – think gold, oil, corn, copper, and so on. The price of each commodity is driven by the difference between its supply and demand. Like stocks, commodities tend to perform best when the economy is growing and demand for “stuff” – which commodities are needed to make – is high. But there’s one exception here: gold, which is often considered a currency since investors use it as a store of value.
Commodities can provide a buffer against inflation since they’re real – literally physical – assets. You could even say they are inflation, since they represent a significant share of how inflation is measured. Thing is, while commodities do tend to rise and fall in cycles, there’s no empirical evidence that they rise in value over the long term. So while you might want to hold commodities to hedge against inflation or when you think economic growth will be strong, you shouldn’t necessarily always hold them as part of your portfolio.
Real estate refers to residential and commercial properties, which are also categorized as real assets. Like stocks and commodities, real estate tends to perform best when the economy’s in good shape, but it struggles when the economy turns over. And like commodities, real estate tends to be quite resilient to higher inflation. Historically, its returns have been between that of stocks and bonds.
Finally, you have alternative assets – a broad term for non-traditional assets like hedge funds, private debt, and art. Investors buy alternative assets because they tend to move differently from traditional asset classes. But while they do provide attractive diversification benefits when markets are rising, they also tend to be negatively impacted by slower economic growth and stock market crashes.
There’s no guarantee that today’s top companies will rule the roost tomorrow. That’s why the world’s indexes are always updating to keep track of which ones are going strong, and which are stuck in a rut. Makes sense, then, that you’d want to update your portfolio to make sure you only invest in the best.
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The art of multi-asset investing – much like cooking – depends as much on which ingredients you choose as it does how you combine them. Creating your perfect meal really depends on your constraints as well as your preferences.
There are broadly three types of objectives that multi-asset investors can achieve:
Growth. Risk-tolerant investors who want to generate the highest returns should hold a high proportion of stocks, real estate, commodities, and alternative assets. That’s because those assets tend to generate the highest returns over the long term. However, this type of portfolio would be quite risky, and could be subject to big losses when the economy dips into recession and investor sentiment turns sour.
Income. Investors who favor regular cash flows over capital gains should own a combination of corporate bonds, government bonds, and high dividend stocks. While that portfolio is likely to generate lower returns than a growth portfolio over the long term, it’s less likely to result in sharp losses. You can even make your income portfolio more or less defensive by altering the mix between safer government bonds and riskier dividend stocks.
Balanced. Investors who don’t have the willingness or capacity to handle big losses might prefer a balanced portfolio. Investors can design a balanced portfolio that performs well under different possible economic scenarios by owning a diversified mix of bonds (performs well in low growth, low inflation), stocks (high growth, low inflation), gold (low growth, high inflation), and commodities (high growth, high inflation). While that portfolio probably won’t generate returns as high as the growth one would, it’s likely to perform well in most conditions and is unlikely to experience sharp losses. To make it more defensive, investors should make sure the proportion of government bonds at least matches the combined proportion of stocks and commodities.
And like the best stew, the full benefits of those portfolios will reveal themselves over time – so don’t judge the results before they’re ready.
This guide was produced by Finimize in partnership with TradeStation.
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.