As we rocket through the new year, stock market investors have reason to celebrate. The S&P 500 index has surged by 6% and has surpassed 5,000 for the first time ever. This impressive growth has been largely driven by tech giants like Meta and Nvidia. Meanwhile, Japan’s Nikkei 225 is on the brink of surpassing its own record set back in 1989. With such a promising start to the year, the age-old debate of whether investors should go all in on equities has been reignited.
In financial circles, there’s a buzz about some interesting research that was published in October. Aizhan Anarkulova, Scott Cederburg, and Michael O’Doherty, a trio of academics, argue in favor of a portfolio consisting solely of equities, opposing the long-standing advice of a mix of stocks and bonds. Their research, based on data going back to 1890, suggests that a portfolio entirely made up of stocks is likely to outperform a diversified approach.
But why stop there? Some experts are even advocating for young investors to take on borrowed money to invest in stocks, leveraging the long-run compounding effect of capital growth. However, not everyone is on board with this aggressive approach. Cliff Asness, founder of AQR Capital Management, acknowledges the higher expected return of a portfolio of stocks but cautions against the risk associated with it. He advocates for a balanced portfolio with the option to borrow to invest in more of it, achieving potentially higher returns without the excessive volatility of a 100% equity allocation.
The challenge with allocating 60%, 100%, or even 200% to equities lies in the fact that financial market history is relatively short. Most research relies on data from the late 19th or early 20th century, leaving young investors with a less-than-ideal basis for making decisions for the next half-century of their lives.
Even when taking a longer-term view, analysis of data dating back to the late 18th century shows that stocks did not consistently outperform bonds before 1941. This challenges the notion of using data from such a distant era to inform investment decisions today, but it highlights the unpredictable nature of the financial market.
Advocates for diversification often find themselves at odds with a market that’s rallying, but history provides plenty of reasons for them to stand firm. The lack of recent evidence on relative returns and insights from earlier periods show that reliance on long-term returns is not sufficient.
As we navigate through 2024, investors are faced with the challenge of balancing their risk and reward. While the allure of a fully equity-based portfolio is tempting, the cautious approach of a balanced mix of stocks and bonds has a solid foundation in historical data. The long-term outlook of financial markets remains uncertain, and investors will need to carefully weigh their options in this ever-changing landscape.
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