Renowned international investor and author, Dr. Marc Faber, is fond of saying that investors in today’s financial world need to be their own central banker. What I think he means is that you need to hold a large portion of your assets (wealth) in a form that cannot be debased by the actions of profligate central bankers. With this in mind, Marc likes gold, farm land, and property (in some parts of the world).
I agree with Marc, but I would go a step further and say that investors also need to be there own financial advisor.
For the most part financial advisors rely on a form of Modern Portfolio Theory (MPT). Developed in the 1950s through to the early 1970s, MPT utilises mathematical models which attempt to maximize portfolio returns based on an investor’s tolerance for risk.
This risk assessment takes into consideration a persons age, income and investment goals and is usually conducted via an extensive questionnaire, the results of which are fed into a computer. The computer then generates a recommended asset allocation based on its mathematical models. A typical portfolio asset allocation would look something like this.
A Typical Portfolio Asset Allocation
Notes: This is a real example. The financial adviser will typically recommend a selection of funds to fit each asset class.
The problem I have with this traditional ‘cookie cutter’ approach, is that it ignores the macro financial and political environment in which we live and operate. Instead the model makes recommendations based on past stock, bond, and property market performance, and because markets are cyclical, if you invest by looking in the rear view mirror and using data from the past 25 years, you will almost always lose.
For example, the 62% the model has allocated to equities clearly fails to acknowledge the fact that stocks are in a secular bear market, and, adjusted for inflation, are significantly below where they were at their peak in March 2000.
The same lack of current market appreciation is true of the allocation to bonds (Gilts). The bond market is in an enormous bubble and is nearing a major (multi-decade) top. Investors entering the bond market are facing both lower bond prices and returns that are deeply negative when adjusted for the rate of inflation. They are also exposing themselves to massive potential counter-party risk.
Without going into the property or cash components of the portfolio which are also fraught with risk, suffice to say that an investment in the above portfolio would, in my opinion, lose you a lot of money.
Investing without first establishing a macroeconomic word view is foolhardy. Investors owe it to themselves to do their own homework so that they can become there own financial advisor.