Thoughts on Current Asset Allocations

The stock market has long been an engine of growth for investor portfolios. That makes sense—it reflects and participates in the steady expansion of the global economy. Over time, stocks have treated investors well.

That said, are investors currently over-allocated to equities? Several surveys suggest that U.S. investors are now holding stock allocations at or near all-time highs.

Strategically, there's a reason why long-term allocations to the stock market have historically been lower than they are today. Behavioral finance tells us that diversified portfolios—balanced between equities and non-equities (like bonds, alternatives, and real assets)—tend to produce smoother rides and better investor experiences over time.

It’s likely that many investors today are taking on too much risk. Then again, that’s usually the case - especially in the depths of bear markets. As Rob Arnott put it:

“People need to gauge their risk tolerance. It is almost impossible to gauge your risk tolerance with any precision, but you can safely assume that your tolerance for downside risk is considerably less than you think it is.”

Even Harry Markowitz, the father of Modern Portfolio Theory, is famously reported to have allocated his own portfolio to 50% stocks and 50% bonds. His reasoning?

“I split my contributions 50/50 between bonds and equities. My intention was to minimize my future regret.”

Benjamin Graham, the father of fundamental analysis, also advocated for a base allocation of 50% stocks and 50% fixed income. He recommended a maximum of 75% in equities and a minimum of 25%, with the equity weighting based not on age, but on an investor’s objectives, personal considerations, and market conditions. In his view, if the market appeared expensive, a lower allocation to equities was warranted, and vice versa.

Today, by most measures, the stock market is indeed expensive. Valuations are near all-time highs, especially when viewed through the lens of price-to-sales ratios. Expected long-term returns from equities are therefore lower. The dividend yield on stocks is even less than the yield on Treasury bonds—a rare occurrence we haven’t seen in decades. Simply put, investors aren’t being compensated adequately for the volatility and downside risk of equities.

Of course, bonds aren’t without risks either—especially in an environment of elevated inflation, political uncertainty, and growing debt levels. While bond yields are at their most attractive levels in two decades, total return prospects could still be compromised—especially if investors don’t hold bonds to maturity.

That opens the door to other non-equity options, including alternatives, real assets, and perhaps even a small allocation to cryptocurrencies.

For years, the 60/40 portfolio has served as the “base” balanced portfolio. Increasingly, many are now advocating for a 60/20/20 approach—stocks, bonds, and alternatives/real assets. But perhaps, given today’s risks and opportunities, a more prudent starting point is a 50/25/25 mix—before layering in personal objectives and constraints.

After all, a smoother ride often leads to a stronger destination.