The allocation between Owning, Loaning and Reserving will determine 80% to 90% of your portfolio return. Selections within Own, Loan and Reserve will determine the rest.

OWN: The stock market Bull is very strong, but its sustainability is in question.

Momentum is high, and profits are growing, but valuations are stretched and partially dependent of low interest rates, which now are rising. Advisor and investor positive sentiment toward stocks is extreme, but extreme sentiment is often a contra-indicator.

—-International is more attractive than domestic; and emerging markets are more attractive than international developed markets; commodities may benefit from global growth.

LOAN: The historic bonds Bull has turned the corner and is now in a Bear mode.

Bond yields are low and credit yield spreads to credit-risk-free Treasuries are compressed; but interest rates are increasing and will increase more due to (1) Fed overnight rate increases, (2) reduced bond purchase demand from the Fed, and (3) increased supply of new issue bonds from the Treasury. Rising yields will reduce bond prices, which will be an offset to bond yield, resulting in unappealing real (after inflation) and after-tax returns.

—-Investment grade floating rate bonds are the most attractive domestic bonds, and US Dollar denominated emerging market sovereign bonds offer the best yield net of inflation.

— For income-oriented investors, equities, such as high yield stocks, certain limited partnerships, and REITS purchased substantially because of their income characteristics may see their returns impaired, until and unless their payout increases the yield to be competitive with bonds once again.

RESERVE: Yields are rising, but cash is only useful for tactical or operational purposes.

It is nice to get paid something for tactical cash reserves while waiting for better pricing of bonds or stocks, but current real yields are negative for tax deferred accounts, and more negative after-tax for regular taxable accounts. However, that loss is capped at the real, after-tax return, whereas stocks can go down a lot and some bonds are likely to lose more than cash.

Discussion:

Example of Current Allocation Opinion in Use:

Assume that the investor has all assets in a tax deferred account, so tax considerations are not an issue; and assume that investor’s policy target allocations are: OWN 65% (min 60%), LOAN 35% (min 30%) and RESERVE 0% (max 10%).

That is not an allocation policy recommendation, merely a common policy level among investors in or near retirement.

If the current QVM opinion were implemented, the allocations would be approximately: OWN 62%, LOAN 30%, and RESERVE 8%.

Arguments:

Isn’t it a bit stupid to reduce stocks allocation during such a strong Bull?

YES, it may be if your goal is to squeeze all the potential profit from the Bull; and are prepared to endure a large Correction or the next Bear, or you believe you can exit or reduce stocks at the peak, and not after a large decline (including the instance of a shock event the precipitates an immediate stock decline).

BUT NO, it is not stupid if you would not cope well emotionally or financially enduring a large Correction or the next Bear; or you would want a lower stock allocation before a Correction or Bear; and are not confident that you either could or would make the reduction before the drop. Sleepless nights may not be worth the extra potential. Selling assets to fund retirement during a significant stock decline may reduce your portfolio’s longevity. Nobody ever lost money taking a profit. Even if you do not allocate below your policy target level, you may need to reduce stocks just to get back down to your policy level, given the recent large gains in stock prices.

Isn’t is a bit stupid to hold cash at all?

YES, it may be for amounts over an above what you expect to withdraw over the next 12 months, because with 0.75% to 1.25% current money market rates; and current inflation approaching 2%; and federal, state and local income taxes near 50%; cash is a guaranteed loss of purchasing power.

BUT NO, it is not stupid to the extent that you find it uncomfortable or inappropriate to hold full measures of OWN or LOAN. If there is not an attractive home for all your assets in things to own, or loans to make; then the only other place to put your money (other than under your mattress) is in a cash instrument (money market fund, bank CD or perhaps a ultra-short bond fund with an average maturity of 3 months or less). Cash is a guaranteed purchasing power loss, but that loss is limited, known and more attractive than potential losses you may see as likely in stocks or bonds at various times.