When the markets tank and take a chunk of your wealth, all that gets you through the day is faith; faith your financial advisor knows what he’s doing or, if you pick your own investments, that your strategy willhold up. The last week has been a big test in my faith not only as an investor, but as an economist. That’s because while many of my peersdon’t apply economics to their investing, I actually do. Right down to my Fama-French tilts. My portfolio is a near perfect reflection ofmy macro training andhalf a dozen years mentored by Nobel Prize winners on how to adapt high finance to retail investing. But that approach sometimes puts me at odds with advice pushed by the personal-finance industry.
My brokerage firmsays mystrategy is too aggressive and not well diversified, even though I consider myself risk averse. Where wediverge is how wedefine risk. Their strategy seems built to ensure I’ll never lose or gain much more thanmost other peoplein any given day. But that strategy does not necessarily satisfy my personal investment goals. I don’t care how I stack up against my friend’s portfolio. I follow what economists call life-cycle investing—a combination of maximizing my wealth and never taking a big hit in terms of my lifestyle.
Somedays I’ll do much better, other days much worse than people I know. Indeed, my strategy put me in the worst performing stocks lately. And I was warned: The brokerage firm where I keep my money has analgorithm that regularly assesses my portfolio and it keepstelling me I am invested all wrong. But I am still not giving up (or looking at my account balance). Here’s why I have faith in my choices, even if they look off targetby certain standards:
How I view my assets
For obvious reasons thebrokerage firm steers me into their high fee mutual funds. My finance training fights their recommendations and I go with cheapindexed funds. Index funds have become the go-to investment choicethese days, but the onesI chose iswhere things get controversial.
Bonds, for example,only make up 7% of my investment portfolio, which I’m told is not enough. The conventional wisdom is that younger people need fewer bonds, but how much exactly seems to vary with the current state of markets.Right now, bonds are up, stocks are down.The brokerage firm tells me my7% should really be 25%. But since you can’t time markets I’m sticking with my choice.
Besides, I thinkI already have enough bonds. My largest asset isn’t my stock portfolio, it’s my futureworkincome because I am still relatively young. Future income—essentially a stream of payments I expect—is similar to a bond. And by my calculation, my true bond exposure is more like65%.So even if the stock market drops, my actual wealth has not changed that much.
As I get older my future earnings will be a smaller share of my portfolio and I plan to move intobonds. But my reallocation will be driven by the length of my remaining career and how risky my earnings are, not the current state of the market.
How I see markets
As bad as the US stock market is, other countries are in worse shape. I am regularly told my portfolio has too much foreign exposure. Across all my accounts I have about 35% of myportfolioinforeignstocks, and I’m told I should have just 21%. But, like all good economists, I eschew any home bias. My income is already tied to the US economy, so why put almost all my wealth there? The US economy may look better than the alternatives today, but that may not be the case in 30 years. Perhaps the US will prove more stable, but that may mean less growth over the long term.
My macro training and belief in the power of markets lead me tobelieve—present turmoil aside—poorer countries will grow faster than rich ones. Their demographics are better and there is more upside potential. Sonot only am I heavyinforeign stocks, I own lots of stock inemerging markets, whichare getting pummeled. But my finance training tells me there’s no reward without risk. Emerging markets promise higher returns, but they come with weeks/months/years like this.
How I determine my savings
I’m also told I’m not saving enough forretirement—which is strangesinceI’m a pension economist. When I signed up for Quartz’s parent company’s 401(k) recently I got many stern warnings that I should save at least 10%of my income for retirement. Instead, I’m only saving up to the company match because anything less is leaving money on the table and anything more ties up my money when I need liquidity.I agree 10% is the right goal and I am actually saving that much—just not in my 401(k) or the stock market. My usual career choices expose me to variable income, but I like to maintain a stable lifestyle. Thatmeans I need to keep a large amount of liquid savings invested in cash or short-term securities. I’m prepared for days like this, and that peace of mind affords me the luxury of not looking at my brokerage account.
Sometimes I think the brokerage firm isright. Not because a stock market plunge killed my portfolio but because I am poorly diversified in one sense. My professional reputation, and future earnings,depend oneconomic and finance theory being right. I am long economics in both mywealth and future income. In that sense, I am totally exposed.
