You know what you do with your portfolio when the stock market behaves badly? You move to those timeless stores of value: cash, gold and real estate.
Or at least that's what some investment strategists are suggesting in response to market malaise. They certainly aren't not alone. Just search on Google for advice about the wisdom of investing in cash, gold or real estate and you'll find a chorus of voices singing the praises of those traditional havens.
Despite such popularity, my guess is that few sophisticated portfolio managers actually attempt to sidestep the market's vagaries by hiding in cash, gold or real estate – and for good reason.
Consider that the simplest 60/40 diversified portfolio made up of the S&P 500 index and long-term government bonds has returned 9.9 per cent annually from 1972 to 2015 (the longest period for which data is available for all investments referenced in this column; those returns include dividends).
Cash, as represented by 30-day Treasuries, returned 4.9 per cent annually over the same period. Gold returned 7.5 per cent annually over the same period. And real estate, as represented by the FTSE NAREIT U.S. real estate index, returned 9.7 per cent annually over the same period.
On a risk-adjusted basis, gold and real estate fared even worse. The 60/40 portfolio has a Sharpe Ratio of 0.48, whereas gold and real estate have Sharpe Ratios of 0.13 and 0.27, respectively. (The Sharpe Ratio gauges risk-adjusted returns, with a higher ratio indicating that investors are more adequately compensated for volatility. The Sharpe Ratio of cash is zero because the Sharpe Ratio measures the excess risk-adjusted return over cash.)
So cash, gold and real estate have been no match for a simple diversified portfolio over the long haul. But here's the more crucial twist: They also haven't even been a sure-fire hiding place during market routs.
There were four ugly multiyear episodes for U.S. stocks between 1972 and 2015, as measured by changes in the value of the S&P 500. The first episode was the Nifty Fifty crash of the early 1970s. The 60/40 portfolio declined 29.6 per cent from December, 1972, to September, 1974, but real estate investors were less fortunate, suffering a decline of 52.6 per cent over the same period.
The second episode was the stagflation recession of the early 1980s. The 60/40 portfolio declined 3.7 per cent from November, 1980, to July, 1982, but this time it was gold investors' turn to get hammered with a decline of 44.7 per cent over the same period.
The third episode was the post-tech bubble collapse of the early 2000s. The 60/40 portfolio declined 21.2 per cent from August, 2000, to September, 2002, and this time investors got what they came for – cash, gold and real estate all appreciated in value.
The fourth and most recent episode, of course, was the 2008 financial crisis. The 60/40 portfolio declined 29.7 per cent from October, 2007, to February, 2009, but real estate investors were left poorer yet again, suffering a decline of 63.2 per cent over the same period.
Given that cash, gold and real estate appear to be less than perfectly correlated, you may be wondering whether a combination of the three would have been the silver bullet. No dice there, either. An equally weighted portfolio of the three would have declined in two of the four bear markets – by 8.5 per cent from November, 1980, to July, 1982, and by 20 per cent from October, 2007, to February, 2009.
All of this means that investors who are hell-bent on sidestepping bear markets have a near-impossible mission. For starters, they have to time their market exit and re-entry to near perfection, which is famously difficult to do.
But that's just the beginning. Investors also then have to predict which of their desired ports of call – cash, gold or real estate – will actually hold up in a storm. Granted, cash should always hold up (and if it doesn't, heaven help us all), but it also inflicts the most severe penalty for mistiming the market, as it will fall farthest behind over time.
So investors shouldn't look longingly at cash, gold or real estate right now, even if their portfolios seem shaky. They should just stay the course, because sometimes a port in the storm is much more dangerous than it appears to be.