Fixing Your Mix

Adam M. Grossman

WITH YEAR-END IN sight, it’s a good time for some investment housekeeping. What’s worth your attention? Last week, I discussed the importance of asset allocation. According to research, this is the most significant portfolio decision you can make. But while asset allocation is important, it isn’t the only decision. Within each of the major asset classes, there’s another set of considerations.

Bonds. Earlier this year, I conducted a survey on X, as Twitter is now known, asking whether a total bond market fund would, on its own, be sufficient to fill an investor’s bond allocation. Nearly three-quarters of respondents said no, and I share that opinion. Why? The bond market is larger and more diverse than the stock market and, for that reason, a broadly diversified basket of bonds may not be what best serves investors. Instead, investors may wish to narrow their bond holdings along several dimensions.

The first dimension is what’s known as duration. A bond’s duration is similar to its maturity, and measures how long it would take an investor to get their money back. Bonds with longer durations—or bond funds with longer average durations—face more risk when interest rates rise.

That’s precisely what we saw in 2022, when total bond market funds, which have a duration of around six years, lost 13% of their value. By contrast, funds with shorter durations experienced much more modest losses. For example, Vanguard’s Short-Term Bond ETF, with a duration around 2.6 years, lost just 5.5% last year.

The next consideration is the type of issuer. Bonds are issued by the federal government, by state and local governments, by foreign governments, and by corporations. And all of these, with the exception of U.S. Treasury bonds, are available from issuers of all different levels of creditworthiness.

A final consideration when choosing bonds: whether to invest in a bond fund or individual bonds. You can find high-quality, low-cost funds covering each corner of the bond market, plus investing through funds typically makes life simpler.

Still, there’s an exception to consider. With yields at 15-year highs, you might want to build a ladder of individual bonds to lock in today’s yields. If you go this route, I’d offer one caution: Because the bond market is far more opaque than the stock market, the only type of bond I’d purchase individually would be U.S. Treasurys. Because of its size, the market for Treasurys is much less opaque.

Remember, the bond market—unlike the stock market—has no centralized exchanges with quoted prices. That makes it much easier for professional bond traders to take advantage of individual investors. The upshot: For bonds other than Treasurys, I’d opt for a fund or, depending on the size of your portfolio, a dedicated bond manager. I wouldn’t try buying municipal, corporate or international bonds individually.

Real estate. For many years, real estate seemed to only go up. But with elevated interest rates, some corners of the real estate market are seeing declines. This presents an opportunity for buyers. Intrigued? There are at least four key decisions to make.

First, decide whether you want to participate via equity or debt. In other words, do you want to own a property, or do you want to be a lender to those who are buying properties?

Second, if you opt to be an owner, decide whether you want to own property directly or through a fund. Owning a rental property directly generally results in much better economics for the investor. It also, however, means more work. There’s no right or wrong answer here, but it’s probably the most important decision for real estate investors.

Third, decide how you want to allocate your available funds among properties. If you invest all your money in one single-family home, for example, you’ll gain simplicity but give up diversification. Choose a multi-family property or a collection of smaller homes, on the other hand, and you’ll have more to manage, but a problem with any one unit won’t be as damaging.

Fourth, think about geography. If you’re managing a rental yourself, it’s ideal if it’s close by. On the other hand, if you don’t mind hiring a property manager, you might benefit from diversifying geographically.

Stocks. In another survey I conducted this year, I asked readers whether a total stock market fund would be sufficient to fill an investor’s stock allocation. As with the bond survey, only a minority said yes, but the percentage was notably higher. In other words, more investors would be satisfied with a total market fund for stocks than for bonds.

That result makes sense to me. As discussed above, the bond market is much more diverse, and certain types of bonds simply don’t make sense for certain investors. With stocks, that’s far less likely to be true, so investors’ best bet is to opt for broad diversification. Indeed, with stocks, the key risk is being too concentrated—in other words, being under-diversified.

If you’re reviewing your stock holdings, that’s the primary screen I recommend. Examine whether your stock holdings are too heavily weighted in one company, one industry or some narrow slice of the market. Because of the runup in technology shares, it’s not uncommon to see portfolios with a huge bet on a handful of stocks, such as Apple, Amazon and Microsoft. A variety of tools, including Morningstar’s X-Ray, make it easy to look under the hood of your portfolio and see risks like this.

A final note. Across all asset classes, there’s another key decision to make: whether to invest only in publicly traded investments or to get involved with private funds. To be sure, private funds have an allure. But they’re also characterized by high fees, illiquidity, lack of transparency and often tax-inefficiency.

That’s why the late David Swensen, who promoted the use of private funds during his long tenure running Yale University’s endowment—and had great success with that strategy—went out of his way to advise individual investors to do precisely the opposite. In fact, he wrote an entire book on the topic. As you think about investment choices for 2024, this is a key factor to keep in mind.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X (Twitter) @AdamMGrossman and check out his earlier articles.

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