How Zero Interest Rate Policy is Changing Asset Allocation

May 6th, 2015

Blossom Wealth Management strives to be on the cutting edge of changes in the investment industry. Over the next several weeks we will examine the zero interest rate monetary policy and the effects this is having on investor’s asset allocation and portfolio returns.

Bonds: An Un-Productive Investment

When you take an in-depth look at the Investment Industry, you will realize that the stock/bond allocation ratio of 60/40 has been dominant for many years. How is it possible for two types of assets that are so diverse to work so well together? There is a simple explanation that I would like to offer to that question.

Over time, high volatility and high return potential have been the hallmark of stocks. Even though most portfolios include stocks, they have to be tempered by an investment that provides low volatility and moderate returns, thereby making portfolios more stable and less volatile than stocks alone. Bonds have truly earned their keep especially over the past 4 decades where we have seen an increase in market volatility coupled with lower returns on equity. They have been able to offer low volatility with reasonable returns, earning 7% per annum with an approximate 10% decrease in volatility (Barclay’s Aggregate Bond Index as our benchmark). But all of these statistics exist in the rear view mirror, we want to ask the question: how long bonds will be able to keep this up.

Chart 1Yale University’s Robert Shiller has tracked the history of 10 year treasury yields dating back to 1900. The 10 year Treasury yields have declined to under 2% creating a boom in bond prices but this has lowered yields to unattractive levels.

In the simplest of terms, bonds are losing their luster becoming an asset class that is non-productive. As we take a look at the global markets, many countries in Europe now have negative rates of return on their short term government bonds. Bonds are no longer seen as “Return On Capital” but instead as “Return Of most-but-not-all-of-your-Capital.”

Blossom Wealth Management believes it is time to begin exploring new sources of stable, low volatility returns. In the coming weeks we will be examining productive alternatives that will allow investors to increase returns on the conservative side of their portfolio while lowering risk and volatility. If you are tired of seeing poor returns in your bond portfolio, stay tuned for our next blog post.

 

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