Jack Hough's Streetwise Column in Barron's took an interesting turn this week. He said that all any investors need is a stock index fund, probably just an S&P 500 fund and a bond fund. Maybe a little into an international fund but you don't need emerging markets. REITs? Forget about 'em. Commodities? No way. Thematic funds? Get outta here with that.
Regarding bonds, Jack said "You need bonds—not because they’re good for making money, but because they hold their value better than stocks when the market goes kablooey." First, of course what he is saying is valid. The plainest vanilla stock/bonds mix will get the job done over the long term.
Also included in the list of things investors don't need were options, preferred stocks, convertibles and private equity. Part of his logic is that many of these things are in the S&P 500, you're already getting them. That is correct, technically but whatever you're looking for from REITs, or private equity or any of the others, you're not going to see it impact the portfolio as part of an index fund. In the case of real estate a 2.29% weighting and for "private equity" companies it's about 17 basis points (looked at XLF holdings and then did a little math), that's just not going to move the needle.
You may agree with Jack about not needing those things, that's valid, my point is that owning an index fund isn't a proxy for them.
More interestingly than what investors may or may not need is a pretty obvious behavior on display in the column. Regardless of what stocks should be doing these days, equity markets markets are doing fantastically well. Note that stocks do what they shouldn't all the time which is why it is best to avoid jumping all the way out. Times like now, at all time highs, make it easy to talk about just owning an index fund, having a heavy allocation to stocks and thinking you can just hold that and chill. It reveals complete amnesia about what it feels like when we are grinding through a large, serious decline.
Forgetting is a normal thing for investors, I've seen it repeat over and over. I certainly have no idea whether Jack gets scared during large declines (I doubt it) but it is important to remember what your reaction and thought process was during 2022, the Pandemic Crash in 2020, whatever the hell happened in December 2018, going back to the Financial Crisis, the Internet Bubble, Long Term Capital blowing up in 1998, the Asian Contagion in 1997, Orange County's bankruptcy in 1994, Iraq bombing Kuwait in 1991, the failed UAL LBO in 1989, the 1987 Crash and a whole bunch of others in between that I am forgetting.
Mistakes during those types of events are what managing portfolios is all about. Market discipline matters after large declines, avoiding panic is avoiding permanently impairing your capital. I've cited the example a few times of bonds bought 3-4 years ago when rates were at their lows that now have 30% paper losses and below market yields for holders. That would be a terrible position to be in but anyone selling would be hard pressed to make that money back in the bond market. Market discipline matters at all time highs to avoid greed, to avoid panic buying only to get whipsawed by the next large decline.
Closing out on Jack's comment that "you need bonds..." If he means duration, the part of the bond market that is volatile, we've written 100 posts debunking that. The volatility regime of duration and the correlation attributes make them far less useful for diversification than they used to be. Of course "used to be" was a 40 year bull market that mathematically cannot be repeated. I continue to focus on short term yielders and low volatility alternatives that function as proxies for what I think people hope bonds will do. Bonds might be valid but are far from optimal.
Remembering the emotion felt during market events is a great way to minimize mistakes. Whenever the next scary market event comes, it will eventually end, the market will then start to go up and eventually make an new high, the only variable is how long that all takes. I've been repeating that last sentence for I don't know how many years, it has always been true and I will always believe that it will be true for future market events.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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