How to allocate a well-balanced portfolio

The 60/40 portfolio, consisting of 60% U.S. stocks and 40% U.S. Treasury bonds, has become the cornerstone makeup of most portfolios ever since John Bogle of Vanguard released the company’s Balanced fund several years ago.
Generally, in most years the 60/40 portfolio has provided good returns, with some years going below expectations, such as.when the selected stocks in a 60% allocation were not the best that could have been picked.
Still, as a general statement, if you believe in the U.S. economy and government, the 60/40 allocation should work well for most people.
As the U.S. economy grows, a well-selected set of stocks from the S&P 500 coupled with long-duration Treasury bonds and some short-term bills, if managed well, should give decent returns in most years.
Sometimes a hedge is needed
The problem is if the assumptions above are no longer true. For example, during periods of recession where the economy shrinks or contracts, stock prices generally fall to reflect the projected smaller discounted present value cash flows they would get.
Or, if Congress fails to rein in spending, the U.S. debt-to-GDP ratio will keep growing. At some point, bondholders might hesitate to buy more bonds because the U.S. then becomes like a credit card holder who does not pay their bills but still insists on charging more to their card.
Then the U.S. Treasury will likely be forced to offer higher yields to attract buyers, which would raise our interest payments and thus increase our deficit even further.
Plus, when the U.S. prints more money that is backed by debt and not actual revenue from tariffs and tax collections, inflation rises and further dampens the real economy because of the excess currency in the system.
Because of these factors, I believe that with the current situation, it is wise to add an uncorrelated hedge to one’s 60/40 allocation.
An uncorrelated hedge is a protective investment against situations where both stocks and bonds underperform, partially due to the reasons I described earlier.
In other words, you want some of your bets to win to counteract losses in others. If all your bets are correlated, then you could lose on all of them at once.
Examples of uncorrelated hedges
Some possible uncorrelated hedges to stocks and bonds include gold, silver, ETFs, cryptos, commodities, oil, futures, fine art, luxury watches and the like. The price movements of these assets do not necessarily mirror the movements of stocks (though they sometimes do).
As for how much of your portfolio to devote to such hedges, maybe 4%, more or less, but the actual ratio is up to you. Thus it might be more like 58/38/4, but you determine what it should be.
The thing to remember is that you need to keep allocations to these hedging assets small — small enough that if these were to go to zero, you might have a bad day, but not enough of a loss to wipe you out or feel devastating. .
You also want to pick assets that have a high chance of outperforming the S&P 500 if these do well. In plain English, if you are going to take a risky bet, it better be worthwhile if you win. Otherwise, what is the point of taking the extra risk?
In financial parlance, an asset should have a high alpha (i.e., return over the S&P 500) and ideally a low beta (i.e., volatility). However, sometimes the outsized returns come from highly volatile and very speculative assets, such as cryptos.
The best way to approach this is that if you feel that an asset is extremely volatile price-wise, but can have a potential exponential return, then size your position so that it is small.
That way, if you lose, you will not lose much; but if it goes exponentially parabolic, you at least have a small position in it that could potentially offset any losses from your “safe” 60/40 allocation.
There are no guarantees in life. No one can predict the future. You could get run over just crossing the street.
But if you are hedged properly with a small amount of uncorrelated assets, you might actually grow and preserve your capital despite the many rocky situations you might encounter in the future.
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