While the stock market has been on a record-breaking bull run for much of the last decade, the last two years have been a good reminder that stocks don't always go up. Volatility has forcefully returned to the equity market. Yields on fixed income investments, meanwhile, are still quite low, especially with inflation hitting its highest level in decades.
Taking all of this into consideration, how should investors position their portfolios now? It may be time to look beyond the traditional allocations that served investors so well in the past.
The Markets Have Transformed
For years, investors and their advisors relied on an allocation of 60% equities and 40% fixed income to construct a “balanced portfolio.” And they were served fairly well, at least until early 2000 when a combination of low interest rates and falling stock prices stressed this conventional asset mix methodology.
Nearly two decades later, more sophisticated investors seeking adequate diversification should consider alternatives beyond convenient allocations to stocks and fixed income. Simply put, the 60/40 balanced portfolio that worked in the past cannot keep up with today's rapidly evolving market environment.
A Third Slice to the Pie?
Investors looking to live off the cash flow from their portfolios are struggling to find investments that can provide the yield they need. Unsurprisingly, many of these folks are hesitant to 'give up' the potential returns of stocks if low-yielding bonds are the only alternative. Many investors have succumbed to the temptation of the more volatile equity asset class.
That said, we can never forget that a key factor to consider is overall portfolio risk. Having bonds in a portfolio isn't done solely to achieve yield; a fixed income allocation reduces the portfolio's overall volatility. It’s true that an investor could take a portion of his or her fixed income allocation and apportion it toward a low volatility ETF to increase equity exposure in a risk-conscious way. That trade, however, fails to address the need for income many investors crave.
How about adding a third slice to the pie? Specifically, a covered call strategy that addresses both risk management and cash flow generation may be suitable for many investors.