Asset Allocation During Covid 19 Recession: Ray Dalio

Phoenix1

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I have watched more videos and have read more articles in the past few weeks on how the sky is falling than I've ever read in my entire life. Someone's got to be making a lot of money off of this stuff because it seems like no one's got anything else to say. As far as I know, the market dropped quite a bit in February and March, but began climbing shortly thereafter. It always climbs after one of these cataclysmic shocks because central banks pump money into the system. Things eventually get back to normal. Humanity figures it out, especially now that humanity has something called the computer. I always get a kick out of when people compare the Great Depression with any modern economic downturn. They do realize that computers didn't exist back then, right? With the touch of a finger on a keyboard, central banks can invent money today. It's linked to nothing, so I don't know what all the hubbub is about.

Now, this isn't to say that we should just rest on our laurels as all of this turmoil is taking place. There is some strategy that needs to occur and that's what Ray Dalio touched on in an interview I recently watched. Basically, he said that similar instances have taken place throughout history and when circumstances like this converge, we need to take notice and act. What are the circumstances? Well, first there is the long term debt cycle that needs to be addressed. Second, there's the wealth gap between the rich and the poor that affects the economic environment tremendously. And third, there's a rise in a large political power that's challenging the existing order.

In the video, Ray goes on to discuss each of these factors, which I found interesting. It was sort of like a financial history lesson. What I found much more interesting though was Ray's prescription for all these events.

From the interviewer, Ray was posed the following question: What is the correct asset allocation for this sort of environment?

To answer the question, Ray explained that the investment environment going forward will be very different than that of the past. The most prolific characteristic of the market going forward will revolve around very low returns. Ray seems to think that the one thing investors need to focus on in this day and age is diversification. While someone may have been able to get away with little to no diversification in the past because of the long running bull market, they likely won't fare nearly as well today.

A typical asset allocation for many investors is what's known as the 60/40 split. That's 60% in equities and 40% in bonds. Typically, this split will use ETFs to satisfy its necessity and those ETFs popularly describe the S&P 500 and the entire bond market. VOO and BND, if you will. Ray claims that this simple diversification may not suffice any longer. Portfolios need to be much more broadly diversified, even within the same asset class. Examples of this diversification might include gold (GLD) and inflation protected bonds (TIP). He also mentioned that cash is a terrible asset to be holding at the moment. If I read him correctly, I'd tend to think that currency destabilization is right around the corner and inflation will rear its head thereafter. Both TIPS and gold will somewhat protect an investor from those things.

I'm sure you've seen this scenario out there. Friends and family tell you how they like to keep their money under their pillows. They keep their cash in the bank. Unfortunately, cash actually has a negative real rate of return at the moment. It's costing you money to hold onto your money. If a bank savings account is offering a 0.01% interest rate and there's a 2% rate of inflation per year, a pile of cash's purchasing power is being reduced by 1.99% every year. And in a high inflation environment, that cash can be worth much less year over year. Some people call this an invisible tax. It certainly is insidious.

Overall, Ray says that because of all the uncertainty and risk in the financial environment today, it's critical that an investor diversify well and watch their cash holdings. If you think about it, he's very much correct. The world is in a geopolitical upheaval, we've got a pandemic going on, and economies are on lockdown. And, we're heading into hurricane season in the U.S. to boot. I don't even want to ask what else can go wrong because I don't want to know. But for the markets to be up as much as they are, I don't want to rock the boat.

As a final note, I'd like to mention Ray's emphasis on the value on money and how important he says that will be going forward. Living in the United States, this isn't something that we have to think about all too often, but it seems that the time to concern ourselves with the issue may be arriving. I can't find one person who's financially literate who isn't concerned with inflation in the future. Personally, I'm not sure how severe it'll be or if it happens at all, but I'm not about to bet against it. I'd rather diversify my portfolio correctly. Bottom line: start thinking about taking some money that you've got in growth assets and moving that money into inflation hedges.

Before this video, I had only limited exposure to Ray Dalio. I think he's worth paying attention to though because I like the way he thinks. How do you feel about the current investment environment? Do you think everything will fall apart or are there places to make money in the market. Let me know below.
 
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