If you’re like many investors, you’ve probably noticed that the balance in your investment account in recent days and weeks is lower than it was at the end of December. That’s of course due to the coronavirus outbreak that’s systematically bringing the global economy to a grinding halt.
The natural reaction to this medical scare is to consider ways to diversify your portfolio, so that you’re not entirely as exposed to the correction that’s already started to take hold.
While it might be natural to search for ways to bomb-proof your portfolio, the reality is you should have done so long before the coronavirus gathered steam. And at this point, it might be better to do nothing and ride out the volatility and uncertainty of the markets today.
However, all ten of these ways to diversify your portfolio are meant to be long-term solutions, not just band-aids for the present. Implement some of these ideas and you ought to be able to sleep easier at night.
Ways to Diversify Your Portfolio: Reduce Your Equity Exposure
In recent years, with people living much longer, the idea of the traditional portfolio of 60% stocks, 40% bonds, has kind of gone the way of the dodo bird. BofA Securities analysts Derek Harris and Jared Woodward discussed this idea in an October 2019 research note, The End of 60/40.
“The core premise of every 60/40 portfolio is that bonds can hedge against risks to growth and equities can hedge against inflation; their returns are negatively correlated. But this assumption was only true over the past two decades and was mostly false over the prior 65 years,” the authors stated.
“The big risk is that the correlation could flip, and now the longest period of negative correlation in history is coming to an end as policymakers jolt markets with attempts to boost growth.”
The two analysts argue that high-yield dividend stocks make more sense than loading up on fixed-income investments.
Nationally syndicated money columnist Chuck Jaffe does an excellent job putting the kibosh on the idea that the 60/40 portfolio is dead. Personally, if you can’t stand risk, you ought to have a least some portion of your portfolio in bonds regardless of what the naysayers believe.
Dip Your Toes in the Bond Market
In 2019, Bank of America Global Research says that equity funds added just $8 billion in net inflows. By comparison, bond inflows totaled $1 trillion, bringing the global bond fund assets to a staggering $10 trillion.
Money is flowing into fixed-income because investors see them as a good way to preserve capital in a volatile stock market.
“I’m not so concerned about what happens when interest rates go up. Investors will lose money on these investment products, but it’s going to take a very long time for people’s faith in bonds to be shaken,” said Mitchell Goldberg, president of ClientFirst Strategy. “I don’t really sense that it’s economic news that’s driving a lot of investors towards bonds. I think most of it is age-based allocation shifts.”
Just as Jaffe argued that the 60/40 portfolio isn’t dead, my guess is he would feel the same about bonds in general. As Motley Fool contributor Chuck Saletta recently stated, “Even in today’s low interest rate environment, it can still make sense to own bonds.”
Buffering against extreme volatility (i.e., the coronavirus) is one of those reasons. A very simple way to get bonds in your portfolio is through an ETF like the Vanguard Total Bond Market ETF (NASDAQ:BND).
Consider Stocks With Lots of Cash
When it comes to share repurchases, I’m of two minds.
On the one hand, a company that consistently generates significant free cash flow and has a strong balance sheet with lots of cash is better off spending billions on buying back its stock than wasting the money on ego-driven expensive acquisitions.
While M&A is filled with plenty of landmines, reducing the share count when done appropriately, is an excellent capital allocation lever. The problem is that most companies end up buying their stock at inflated prices rather than saving the capital for times like today when share prices are falling.
One company that will surely be buying back its stock on any significant price correction is Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B). Only in the last couple of years has Warren Buffett lowered his standard for buying back Berkshire stock.
Up until 2018, he wouldn’t do so at more than 1.2 times book value. Now he’ll buy whenever it’s trading below the estimated intrinsic value. In 2019, Berkshire bought back approximately 1% of its share count at an average price of $200.25 a share [$4.86 billion divided by 24.2 million Class B shares, which includes conversion of 4,440 Class A shares].
In the past month, BRK stock has lost more than 10% of its value. With $128 billion in cash at his disposal, we might see more share repurchases over the remainder of 2020.
Companies with significant cash balances and reasonable debt levels are excellent stocks to own in good times and bad.
Broaden Your Horizons Beyond U.S.
No matter how bad things seem to be, there’s always an economy or two somewhere in the world doing better than the rest. You can’t benefit from this reality if you don’t invest beyond your borders.
In 2016, I wrote about “Home Country Bias,” the act of investing a majority of your money into domestic equities, failing to diversify beyond your borders. I pointed out with an assist from Josh Brown, otherwise known as the Reformed Broker, that Americans put 79% of their equity portfolios in U.S. stocks., essentially forsaking investments in other parts of the world.
The good news for Americans? Unlike most every other country in the world, home country bias isn’t nearly as big of a deal given U.S.-listed stocks account for approximately half the world’s market capitalization.
I also talked about this phenomenon in 2017, recommending seven country-ETFs worth considering to diversify away some of the country risk inherent with a U.S.-first investment strategy.
Every person’s comfort level for foreign investment is different, so you mustn’t do it if it’s going to keep you up at night.
Bite Into Real Assets
In recent years, institutional and high-net-worth investors have been putting more of their capital into real assets, sometimes referred to as alternative investments.
“A defining characteristic of real assets is that they are ‘hard’ or ‘tangible’ assets and provide ownership of a store of value. They tend to preserve value in inflationary environments and they can also serve as a diversifier within a growth portfolio, as a result of an expected lower correlation to equity-like asset classes,” stated the January 2019 report, Building a Real Asset Portfolio, from Mercer, a Canadian pension benefit consultant.
The three main real asset classes are natural resources, infrastructure, and real estate.
Large alternative asset managers such as Brookfield Asset Management (NYSE:BAM) and Blackstone Group (NYSE:BX) make investments in all three of these areas. Also, they do a significant amount of private equity investing where they buy private companies, fix and grow them, and then sell them for a profit down the road.
Both of these stocks are a smart way to diversify your holdings beyond traditional equity investments, such as a low-cost S&P 500 index fund.
Buy a Fund-of-Funds ETF
Because I write about so many stocks, I prefer to avoid conflicts by investing in ETFs. Carrying this a step further, I don’t want to worry about rebalancing the ETFs every quarter.
While I don’t spend a lot of time looking at U.S. alternatives, Vanguard’s Target Retirement 2040 Fund (MUTF:VFORX) is similar in asset allocation, with 82% invested in stocks and 18% in bonds. The life-cycle mutual fund has annual fund fees of 0.14%, which is slightly less than half the 0.25% MER on my ETF.
Believe me, when I say this, retail investors have it so much better in the U.S., despite the tremendous growth in Canadian ETFs.
Buy Strong Dividend-Payers
In the section earlier regarding the 60/40 portfolio being dead, BofA Securities’ analysts made the argument that high-yield dividend stocks make more sense than bonds. I’ve already suggested that some exposure to bonds still makes sense.
While I agree that it’s wise to own dividend-paying stocks or ETFs that invest in dividend-paying stocks, I disagree with focusing on yield. A smarter focus would be on companies that consistently grow their dividends on an annual basis.
An easy way to do this is to buy the Divcon Leaders Dividend ETF (NYSEARCA:LEAD) from exchange-traded fund provider Reality Shares. LEAD is a rules-based ETF that utilizes the proprietary Divcon methodology, which identifies S&P 500 companies most likely to increase their dividends.
Currently holding 61 stocks — its top 10 stocks account for 20.3% of the overall assets — LEAD’s generated a three-year annual total return of 15.94% through December 31, 2020, 68 basis points higher than the S&P 500.
Remember, it’s the growth, not the yield that’s most important.
If I could only buy one stock and diversification was the objective, I couldn’t think of a better choice than Berkshire Hathaway, a company whose equity portfolio is worth $217.2 billion with Apple (NASDAQ:AAPL) accounting for 33% of the total.
If Berkshire’s equity portfolio were part of the S&P 500, it would be the 21st largest company in the index. Add in a massive insurance operation, Dairy Queen, fractional jet ownership, and many other private companies that make America great; investors get a giant mutual fund without paying any annual management fees.
Oh, and it doesn’t hurt that you also get the wit and wisdom of Warren Buffet and Charlie Munger, to boot.
Buy This Different ETF
In September 2017, I picked some of the best and worst alternative investments for retail investors to own. One of the ETFs I put on the best list was MNA IQ Merger Arbitrage ETF (NYSEARCA:MNA), which charges 0.77% annually, and makes bets on global arbitrage opportunities.
MNA makes money on the spread between the share price that a buyer pays for an acquisition target and the price MNA pays for the target stock after the news of the acquisition becomes public. It’s betting that a deal will take place. The spreads are razor-thin, so it has to bet on a large number of targets. It currently has 58 stocks in its portfolio.
“If you compare MNA to the S&P 500 Index, you’ll walk away thinking it’s a terrible investment. The reality is that this ETF gives you bond-like security only better because it uses equities instead of bonds to lower the volatility,” I wrote on Sept. 11, 2017.
“Since inception, its worst year was -1.83% in 2010 and its best year was 6.54% in 2013. If you’re looking for a turtle to win the race long-term, this is the alternative investment to do it.”
So far, in 2020, it has a total return of -0.60% through March 4, which is 220 basis points better than the SPDR S&P 500 ETF (NYSEARCA:SPY). It’s not going to make you rich, but it will help reduce your downside risk.
Consider Equity Crowdfunding
You might have noticed in recent years that institutional investors, as part of their diversification efforts, have plowed significant assets into private capital. As a result, private equity firms, including Brookfield and Blackstone, are overflowing with investor commitments and dry powder.
As a result, private companies aren’t in near a rush to go public. That’s resulted in fewer public companies. In 1996, there were more than 8,000 public companies in the U.S. Today, that’s down to a little more than half that amount.
Private capital remains an attractive place for institutions to invest. Unfortunately, the same can’t be said for individual investors. That’s especially true for non-accredited investors (those investors who make less than $200,000 a year, or $300,000 in joint income, for the last two years, or you have a net worth, individually or jointly, that’s less than $1 million).
“Previously, the only people that could invest in startups (or even venture capital funds or private equity funds, for that matter) were ‘accredited investors,’ which basically means rich people who could afford to lose their entire investment without hardship,” wrote Craig R. Everett, PhD, assistant professor of finance, Pepperdine Graziadio Business School, in an email to InvestorPlace. “The SEC historically resisted the concept of equity crowdfunding because startup investing is mind-bogglingly risky and therefore most investors will lose everything and a few will hit home runs.”
However, the SEC is working on adjusting the definition to allow for knowledge and expertise, and not just income and net worth.
One of the best equity crowdfunding platforms in the U.S. currently catering to non-accredited investors is WeFunder, where investors can put as little as $100 into a private company. It’s important to note that many of the opportunities offered on the site are in companies that are relatively new with limited financial track records. Like small- and micro-cap stocks, it’s wise to limit the amount you commit to this area.
My recommendation: Look for equity crowdfunding opportunities that are attracting lots of small investors. For example, if Company A has raised $200,000 from 500 investors, and Company B has raised $200,000 from 50 investors, I would be more inclined to dig deeper into Company A because it’s got a more grass-roots following.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth was long VRGO.