A recent post in the NY Times written by an economist (who made his career in fixed-income) suggests that the optimal asset allocation for most investors is 100% equities:

Looking at rolling 30-year periods, stocks have always outperformed Treasury bills and intermediates, and have only rarely underperformed long-term Treasuries. Even for periods as short as five years, stocks have done better than the various fixed-income categories 71 to 76 percent of the time.

This is consistent with what Warren Buffett suggested to his heirs in a 2014 letter to Berkshire shareholders:

My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.

The primary argument against this is that the emotional turmoil caused by such an allocation results in emotional pain and panicked selling.  A “less risky” (i.e. less volatile) portfolio would provide a gentler experience than the corkscrew roller coaster ride of an all-equity portfolio.

Treasury bonds provide a smoother ride by reducing the superficial risk of financial market volatility.  Unfortunately, the smoother ride comes at a cost in the form of low returns and little protection against the deeper risk of permanent loss due to catastrophic outcomes.

But what if the absolute worst happened?  A pandemic of epic proportions, a nuclear holocaust or the Earth is hit by an asteroid?  Yes, your stocks will collapse but your bonds will be worthless, too….While bonds protect against volatile markets, they do not protect against catastrophe.  Only nonperishable food, guns, and maybe some gold coins are of any use.

Framed in this way, shouldn’t we include a wider range of possible outcomes than those typically included in asset allocation calculators?  Perhaps a more ideal asset allocation would be Warren Buffett meets Doomsday Prepper:

  • 80% stocks (in case global growth perks up)
  • 10% gold coins (in case there is a collapse of the monetary system)
  • 10% survivalist assets (e.g. water, food, fuel, ammo) in case things look really grim.

— AK