At the time of this writing, the millennial generation (born 1982-2002) is past the adolescent years with most of them having already entered the workforce and just beginning to put together a plan for their retirement. Conventional wisdom says save more and contribute to your retirement account and you will be set for a comfortable retirement. This wisdom however makes up only one aspect of the plan for retirement, the savings decision, socking away a part of your earnings for a later date. There is another decision, one of equal if not more important, the investment decision, the decision to invest that savings in productive assets to secure a brighter future. The shifting of that decision into the hands of “experts” who supposedly have your best interests in mind is what we will bring into question. The novel coronavirus pandemic and the associated impacts of lockdowns and business closures have made the economic and investing future rather uncertain. Add to this situation never before seen levels of corporate, sovereign, and personal debt and unending easy monetary and fiscal policy (aka easy credit and money printing and distribution by the government) and it begs the question of the validity of conventional wisdom in investing. This is especially true for the millennial generation whose investment objective of growth differs from that of the older generation’s objectives of income. The investing philosophy described here will not only serve as a solution but also explain why the so-called “risk-appropriate” portfolios for Millenials, which is just a rebalanced version of the Boomer portfolio is not just inefficient but also harmful for Millenials.
The problem with conventional investing wisdom- Linearity
The investing decision, the decision made by money managers who manage investment funds (inluding all retirement and pension funds) have in them an implicity assumption of linearity, that the past predicts the future.
They measure investment returns and risk by looking at the average historic performance of stocks and the average historic performance of bonds they justify the selection of a portfolio of stocks and bonds because that is easily rationalized. By saying that this the mix of assets for a portfolio that has provided the greatest risk-adjusted returns (a fancy way of saying lower variability from year to year) over history they have indemnified themselves from anything that may go wrong because of that asset mix. I mean can you blame an investment manager if he/she is not only basing his decisions on historical data but also doing exactly what everyone else is in his/her profession is also doing? It is this linear thinking, that we can extrapolate the future from the past that we bring into question.
This indemnified mindset and its safety net are so ingrained that the core of this profession no longer questions its validity. The majority of those in the investment management professional are instead focused on the opposite, the short term decisions of which stocks and bonds to include in their portfolios. A focus who’s decisions is made based on looking at the performance of the last 2-5 years and in some cases last one year to decide what investments to choose from.
The issue with linearity is that it is rather accurate in the short run and also accurate in the long run but surprisingly inaccurate for certain short terms periods within the long run. Although it’s almost impossible to forecast, knowing when these inaccuracies in the linearity assumption occur will help a great deal in preparing your portfolio. Lets look at the stock market, the Dow Jones 100 year history
Above is a picture of the stock market and the black line is a representation of its linear assumption, yes the stock market does go up for the 120 year period from 1900-2020, but there are substantial periods of decline as long up to 14 years where the market went against its trend.
What happens if you enter the market at one of these points of time, a point where the short-run assumption of long-run upward linearity is inaccurate? The decimation of savings. During such a period you can contribute $10,000 a year toward your retirement and end up with as little as $25,000 after a 5 year period (less than what you contributed) and much less than the $70,000 to $80,000 you would expect to accumulate assuming the linearity of returns.
Although in itself it is a valid point to prepare for these downturns, this point is especially important to the millennial generation who given their longer investment horizon (avg 30 years until retirement) are more likely to encounter a crisis than a member of the Boomer(born 1940-1960) or 13th generation(1960-1980) who due to their age have a shorter investment horizon.
This brings us to the two cruical questions:
- What are the chances of the linearity assumption being inaccurate in the near term?
- If there we do see a decline in the equity markets, are there measures that managers of millennials retirement fund will take to protect your investment assets from declining.
Q:1 Are we in a bubble?
Before we understand if we are in a bubble or not we first have to develop an understanding of the world that is non-linear. Because, inherently to linearity is the assumption that we build upon the past to reach the future, that we keep growing. And as such, bubbles if they do occur are only small and inconsequential to the greater trend.
An alternate understanding of the world of linearity is an understanding of the world of cyclicality. Cyclicality suggests that, just like seasons repeat themselves, so do human behaviors and the associated aggregated impacts of those evolving but repeating behaviors.
The view of cyclicality requires us to look further back than just the last four decades where the stock market and bond markets have seen a tremedous bull run. During this period of positive demographic changes, easing monetary policy, monetary debasement and widespread credit creation a secular bull market run is easy to comprehend. But looking further back, we notice that this is not always the case, in the last 80 years the economy has gone through decades of both stagnant growth, and decades of decline. During these period of stagnation and decline equities and bonds performed markedly worse than certain other ‘Defensive’ assets. Accepting the existence of cycles over long periods of time, like the investment timeframe of a ‘millennial’, will lead to you understand the need for actively managing the tactical asset allocation makeup between ‘growth’ and ‘defensive’ asset classes during times of growing uncertainty.
To further understand cycles we look at three types of cycles as they refer to the Millennial-Gold case.
- The cycle of Debt: The ages-old cycle of the human tendency to take on more and more debt until we reach a point where we can no longer pay interest on the debt and have to default on that debt. Referenced here from Ray Dalio’s Principles of Debt Cycles
- The cycles of inequality: described best as the cyclical widening and narrowing of inequality in society calculated by measures such as the Gini coefficient. What is even more alarming is the historic precedent that the real leveling inequality is only achieved through violence. Referenced here from the work of Thomas Piketty Capitalism in the 20th century and Great Leveler by Walter Scheidel.
- The cycles of social life: A lesser-known but equally important cycle that ties all other cycles together. It brought about by generational differences, whose “personalities fluctuate according to cyclical variations in the environment in which socialization takes place”. Work that was studied and made public in “The Fourth Turning” by William Strauss and Neil Howe.
The reasoning, evidence, and implications of each of these individual cycle theories are covered in separate articles which the reader can access by clicking on the links to the article above. The one common important implication of all these three cycles is that the current time period is forecast to see a once in a lifetime event consisting of a market collapse(asset devaluation), social change, and political upheaval. The preparation for this event or series of events is the basis of the millennial investing prophecy.
How do you prepare you investment portfolio when a large amount of wealth distruction is forecast? Start by reducing exposure to equities.
Personal financial wealth reached $226 trillion globally in 2019, a 9.6% gain in 2018, the strongest annual growth rate since 2005. If you are part of the 69% of Americans who have less than $1,000 in savings its highly unlikely that you benefitted from this massive rise in equity prices. That money went to the rich who only got richer. If you are looking at past growth and think that you could see the same in the future, I would think again.
Corporate profits have already been shrinking. The demographics which is composed of an aging population that is exiting the workforce and the political pressures of tariffs and immigration all point to depressed economic activity in the years to come.
A millennial portfolio whose focus is long term growth should also not put itslelf at risk of shrinking.
What is the typical current portfolio of a Millennial? If you have a 401k retirement fund and are using the default suggested portfolio is about 85 % equities and 15 % bonds and cash. For someone retiring in 2025 however, their portfolio is made up of 60% equities and 40% bonds and cash, meaning that if we were to see a stock market decline like we saw in 2000 or 2008 where the market dropped to by 50% over the span of about 18 months, the people retiring in 2025 could see their portfolios lose about 30% of its value. That’s insane!
Why would a retirement account of someone who is so near to retirement carry so much risk by exposing themselves to equities? This is because the retirement account has to hit a target of 8% annual growth so that the retiree will have enough in retirement. And with the central bank policy low-interest rates, retirement fund managers are unable to get the higher returns from safe US treasury investments and are having to invest larger portions into equities.
It is true over a sufficiently long investment horizon the stock market will provide superior returns, however, the Millenial Gold prophecy, would suggest that you might want to take a more astute approach to the situation than just give your money to the investment managers to handle.
The millennial investing philosophy is positioned so that the market, as of July 2020, will go up in the short-run( due to FED activity) and crash in the long run. How then do you not only protect your existing assets, not missout on the growth opportunity, and find valuable opportunities to invest in well before a market crash?
The Millennial Gold Portfolio
The Millenial Gold Investment Portfolio is broken up into four objectives Protection, Growth, FOMO (Fear of Missing Out) and Speculation. The weights allocated to each sector and the individual investments within each sector may vary as time passes.
Care should also be taken to reduce the correllation among asset classes involved in the portfolio, so as to maximize the risk-adjusted return. Meaning for example, if gold price drops in one year, it shouldn’t wipe out a big chunk of your portfolio. The asset classess currently are heavily weighted toward Gold due to a belief that we are in a secular precious metals bull market. However, over time the portfolio will take measures to reduce teh correllation of assets in its portfolio.
Let’s assume I have a $100 portfolio: here is the breakup I use.
[Risks: This strategy requires quarterly or annual readjustment, thinking that this is a good 30 year strategy is counterproductive to the arguments made in this article]
- Protection $35
- Growth – $45
- FOMO – $10
- Speculation- $10
PART -1 : Protection
- As the safety of cash as an asset class is reucing because governments are priting money, the protection asset class looks to hold most of its assets in Gold, or gold related funds
- A small amount is held in cash that can be reallocated to other assets in following months.
PART -2 : Growth and Value
- Value and Growth: Gold equities, an undervalued sector (20$)
- Value : undervalued dividend stocks that are recession proof (mainly for diversification) like dollar tree
PART -3 FOMO
Designed to help the investor not miss out on the market’s upward move due to Fed’s policy actions of buying assets. Here we dont ‘Fight the Fed’ but infact are ‘Racing Ahead of It’ through the use of call options on the S&P500.
- SPY December Options at 400 strike price
This is the riskiest instrument on the portfolio and may be reduced to a smaller size in following weeks.
PART -4:Speculation (5-10% of portfolio and a much smaller portion for larger portfolios)
A small exposure (5-10$) to bitcoin included in the portfolio is recommended seeing the future potential of the cryptocurrency as a widely accetped, inflation protected medium of exchange.