Christian Faes is CEO of Faes & Co.
There is a long-standing “conventional wisdom” that says a long-term investment portfolio should be invested 60% in public equities and 40% in bonds. There have been many other variations of this, all usually slanting toward a heavy exposure to public equities. Warren Buffett used to say “90/10” in favor of equities, and the “110 Rule” would have you slowly reduce your equity exposure with age.
But does that sort of portfolio allocation still make sense?
From IPO Boom To Private-Market Dominance
The stock market isn’t what it used to be. Thirty years ago, there were over 8,000 companies listed on U.S. stock markets; today, there are fewer than 4,000 public companies. That is quite a dramatic fall in the number of companies available to investors.
The growth of venture capital, private equity and private credit over the last three decades has allowed companies to remain private longer, and it has also seen a huge number of public companies go the other way and get taken private.
As someone who has personally built a business from startup through to IPO, I am very aware of how being a listed company also comes with all sorts of constraints that can stifle the entrepreneurial spirit of a business. Some companies, understandably, just don’t want to import all of the regulation and bureaucracy that comes with being a listed business. It’s understandable that the number of public companies has been on the decline.
Also, most of the value creation and return from the best companies being built this generation is made for the investors who are able to invest well before the companies go public.
Take, for example, the rumors of SpaceX considering an IPO for $1.5 trillion (paywall). Do you think an investor in that company at IPO has any chance of making the sorts of returns that the early investors will make? That’s not to say it’s a bad investment, but the company raised private capital at a valuation of $36 billion in early 2020, so at IPO, those investors will earn a return on capital that’s over 40 times their investment. It’s hard to see that sort of return being possible for investors coming into a company at IPO at a market capitalization of $1.5 trillion.
Concentration, Volatility And Fragility
In addition to this, the stock market overall has become extremely concentrated toward a small handful of stocks. The Magnificent Seven tech darlings make up about 37% of the total market capitalization of the S&P 500. So if you want to invest in an index to get diversified exposure to the market, these days you are really getting a very concentrated exposure to a small handful of companies.
With a decline in the number of listed companies and an extreme concentration of value in a small number of companies, the diversification available in public equities is increasingly fragile. It is also increasingly likely that public markets will remain volatile in part due to this large concentration of value.
On top of all of this, the outlook for returns from public equities seems to look relatively bleak. Goldman Sachs recently stated that their base case was that the S&P would provide an annualized return of around 6.5% per annum over the next 10 years; and Charles Schwab had a similar outlook of around 5.9% per annum.
Rethinking Traditional Strategies
So, does it still make sense to put 60% or more of your investment portfolio in this asset class? Would you take an investment that is increasingly concentrated, potentially more volatile and has a return outlook that some of the biggest names in the market predict at somewhere between zero and 6.5%? For many investors, it’s a hard case to make.
The investment landscape has changed dramatically over the last three decades, and the rise of alternative investments has created a new paradigm for how investors should construct their investment portfolios. Any investor who wants to have a truly diversified portfolio should be looking at or asking their advisor about what alternatives might make sense for their portfolio.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?
