Balanced Portfolios for a More Realistic Term

David BlanchettIn a previous article, I explored the accuracy of a statement Jeremy Seigel recently made during a presentation at the Investments & Wealth ACE Academy conference in San Diego. He suggested that “while stocks were not a great inflation hedge in the short run, in the long run they were perfect” (he emphasized perfect versus good or great). Using a dataset that includes 16 countries spanning 1870-2020, I found that while stocks may not have technically been the perfect inflation hedge, they were better than cash or bonds over extended periods.

While I assumed a mutually exclusive opportunity in the previous article, whereby one could invest in cash, bonds, or equities, in this article I extend the analysis to solve for the optimal allocations between cash and equities for various assumed levels of investor risk-aversion and investment periods.

Equity allocations should increase over longer investment periods, especially for more conservative investors; but even for extended periods, there is some benefit to taking a balanced approach to risk (i.e., allocating to cash). Additionally, when balancing the uncertainty of future market returns with the ability of an investor to leave a portfolio untouched for extended periods, the results suggest that while the equity allocation of portfolios should increase for longer investment horizons, the adjustment should be less than implied by the historical evidence, and it should be based on each investor’s unique situation and preferences.