The work of balancing a portfolio never ceases. The economy fluctuates, nations rise and fall, nature does what it will. We are all well-advised to react to such exigencies by shifting our resources out of assets that are ill-suited to the new normal and into those that are more likely to thrive.
And while “new normal” is a phrase that’s been thrown around a lot over the past couple decades, it applies now. Government programs are canceled, then suddenly – by a walk-back of White House policy or a judgment of the courts – reversed. Tariffs are imposed, retracted, reimposed and re-retracted. Alliances that go back to the 1940s and diplomatic norms that go back to the 1640s are dispensed with and replaced by … we don’t know what yet.
With so much uncertainty in the air, it might be appropriate to reevaluate the portion of your portfolio allocated to the stock market – which thrives on the opposite of uncertainty – and consider allocating a higher portion of your portfolio to less risky assets in these unprecedented times.
Asset classes in a nutshell
Investopedia defines an asset class as “a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations.” Think equities or fixed-income securities or money market accounts. And those are the Big Three: stocks, bonds and cash. But there are many more, including commodities, real estate, derivatives and “alternatives”. These, of course, break down into smaller nuggets:
- Stocks can be classified as value stocks or growth stocks depending, generally speaking, on their dividend returns. You can also slice them by market cap or by geography.
- Bonds differ in whether they are issued by the federal government, municipal governments or corporations. They also differ by the amount of risk associated with them.
- Cash can be held in money markets, interest-bearing bank accounts or other equivalent funds. Short-term obligations of the U.S. Treasury are also included here.
- Commodities contracts can be underpinned by precious metals, agricultural products or national currencies, each with their own set of exposures.
- Real estate is entirely location-specific, so a property on one side of a divided highway will have different economic drivers than an identical one on the other side. There’s also a huge difference between how residential real estate works as opposed to commercial real estate, which can be further divided into office, retail, warehousing and a host of other functional distinctions.
- Derivatives refers mainly to futures contracts, which predict the prices of other assets as of a certain date or range of dates. These can be stocks, bonds, currencies and interest rates. There are other forms of derivatives, used mainly to offset positions on other investments.
- Alternatives includes private equity as well as its offshoots, venture capital and crowdfunding. This is also where cryptocurrency sits.
Different analysts might deconstruct these differently, but you get the gist. Also, asset classes shouldn’t be confused with investment vehicles. Mutual funds – exchange-traded or otherwise – enable you to invest in a basket of assets within the same class or sub-class. Even if they trade like stocks or sit in a brokerage account like money market funds, they could still have commodities or crypto as their underlying assets. Similarly, real estate investment trusts, or REITs, may be exchange-traded, but it’s still physical property you’re betting on.
Personal finance is tricky. You need to be aware of historical trends while being prepared to disregard them in light of new situations. So, before we ignore history, let’s give it a quick review.
A hundred bucks invested in an S&P 500 index fund in 1970 would yield more than $22,000 by the end of 2023. That’s three times the return of corporate bonds. Commodities, Treasury securities and real estate would have provided somewhat less, but even cash equivalents would offer gains of almost $1,000.
There’s a website called The Measure of a Plan that offers a “periodic table” of asset classes and sub-classes, ranking them by returns over time. It’s worth a look. To sum it up, U.S. large-cap stocks tend to do best, year in and year out. They’re followed by U.S. small caps, emerging market stocks and REITs. Gold is usually a laggard, doing little better than cash over time. When it has a big year, it tends to crater soon after. For what it’s worth, 2024 was a huge year for the precious metal, which surged 23.3%. That’s the same gain it saw in 2020. In case you’re wondering, it dropped 10.3% in 2021.
Whither 2025?
The real question is where to park your money now to come out ahead through the end of the year. U.S. News & World Report calls out 10 of what a J.P. Morgan study cites as the best asset classes as of the end of January.
At the top of the list is crypto because, while ETFs are popping up all over to increase its liquidity and market viability, it’s trading well below its resistance level. The dips might be buying opportunities.
Following that, the study calls out a litany of stocks: growth, international, dividend-paying and small-caps. REITs and commodities follow. Then comes a unique type of U.S. government bond, Treasury Inflation-Protected Securities, or TIPS, which adjust their principal value based on inflation. Other federally backed obligations also make the list, but with this caveat: short- and medium-duration securities only. It might not yet be the season for long-term bonds.
Closing out the discussion is thematic ETFs. Again, we consider ETFs a vehicle rather than an asset class, but let’s just go with it. Thematic ETFs target specific trends, industries or investment themes. If you want to invest in a complicated arena such as artificial intelligence, this might be a good place to start. Similarly, if you expect to retire in 2035, you might want to invest in an ETF that has a target date that maximizes its value as of that year.
At the close
That’s just one opinion, though, as well-considered as it may be. You might have a greater appetite for risk, or you may have a different vision of what the world will be like on December 31. Certainly, you might have more funds to invest and a greater degree of financial sophistication, so you could consider strategies involving derivatives or private equity.
Still, one constant remains: change. When the dust settles, we don’t know what impact tariffs or shifting alliances will have on the U.S. economy and thus on the markets for securities at home or around the world. But, as always, Smith Anglin is watching and evaluating these changes constantly.