Welcome back to the investment landscape after what I hope was a relaxing Thanksgiving! I was fortunate to spend time with family, watch football, and enjoy more good food than necessary. These are all family rituals I enthusiastically look forward to each year.
The investment world has its own end-of-year rituals, including the release of the latest return expectations across asset classes. While no two sets of forecasts are the same, the bad news for investors is the broad agreement is that the strong returns of recent years suggest muted future returns for both stocks and bonds.
Unfortunately, the expectation for lower returns does not mean there's an expectation for lower volatility. This means that investors should expect lower portfolio returns for the same level of risk or consider other investment tools which may help mitigate portfolio risk.
We firmly believe in prudently reducing portfolio risk, and that complementary asset classes and strategies can serve this purpose. Therefore, when considering portfolio construction, we incorporate third-party return expectations and use financial tools to examine risk-return trade-offs of various allocations. To demonstrate, consider the results below from a traditional portfolio optimization:
The table compares a traditional 60/40 portfolio of stocks and bonds to one with a 17% allocation to complements, including real estate, real assets, and private debt. The results show that the additional diversification from complements produces the same level of expected return while reducing the expected risk (standard deviation).
Diversification and risk reduction are so commonly used in finance that the terms can lose their meaning. To highlight their importance, the image below compares the simulated portfolio outcomes of the two portfolios based on their respective levels of risk and return and assuming a starting value of $1.5 million. The simulation also assumes annual withdrawals of $60,000, based upon the classic 4% retirement rule.
By reducing risk, the allocation to complements narrows the range of outcomes. Considering most investors would prefer to improve the worst scenarios instead of emphasizing improvement of the best, the benefit of incorporating complementary strategies is clear.
As always, we encourage you to discuss the benefits and unique risks of complementary investments with your Johnson Financial Group advisor. Although the needs of each client and portfolio is unique, complementary investments can be like sweet potatoes and stuffing; they aren't the main course, but a Thanksgiving meal or investment portfolio just might be better when included.
ABOUT THE AUTHOR
VP Director of Complements Strategy | Johnson Financial Group
In his role as VP Director of Complements Strategy, Jon is responsible for conducting due diligence and selecting investment managers for use across the JFG platform. Jon’s areas of coverage include complementary investments and US growth equity managers. He leads the Complements Strategy Group, which oversees portfolio construction of complementary asset classes, and also serves as a member of the firm's Investment Committee.
