Mohamed El-Erian is a smart guy.
He used to be Bill Gross's right-hand man at global investment firm Pimco, before Gross's spectacular fall from grace.
You'll find his opinion columns gracing the pages of the FT regularly. And an asset allocation strategy of his was among the top performers in a backtest carried out by one of our favourite investment researchers, Mebane Faber, in a recent paper.
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In short, not only is El-Erian a smart guy, but he's also widely respected (the two don't always go together).
So where does he have his money right now? Where does he see the most value today?
Turns out, it's mostly in cash.
Keeping your money in cash may seem very attractive
He admitted that it was "mostly concentrated in cash. That's not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels there is a massive gap right now between asset prices and fundamentals."
Now, it's worth remembering that El-Erian's portfolio will reflect his own priorities. For a start, he's rich. That makes a difference. If you already have all the money you need, your focus falls on capital preservation keeping it intact rather than capital growth.
You're going to be thinking about tax, inheritance, and long-term, multi-generational planning. You might be more interested in setting up and funding your own businesses rather than paying for second-hand equity in the stockmarkets. And missing out on a few years of stockmarket growth is not going to push back your retirement target date.
Still this very smart guy has most of his money in cash. And it's hard to disagree with his arguments. The S&P 500 hasn't been this expensive except during past bubble periods. And bond yields have pretty much never been this low. Everything is expensive.
So what on earth do you do in this sort of environment?
You can't time the market and that's the problem with holding 100% cash
It's telling that John Maynard Keynes arguably one of the smartest investors who ever lived only hit his stride when he acknowledged that he couldn't outwit the market. (If you're a subscriber, you can read more about this in my colleague Cris Sholto Heaton's recent piece on the topic).
So if your investment strategy relies on experiencing regular flashes of genius, you are going to fail. By which I mean, you're going to come out worse in the end than if you'd just stuck most of your money in a simple global tracker fund.
If you want to put all your money in cash, then when do you do it? Today? Next week? And when do you get back in? When stocks fall back to their long-term average value? When they hit a previous bear market valuation?
There's a more sensible way to make these decisions. It's by using asset allocation and rebalancing. I've talked about this before, but I don't think you can go over it too much.
Asset allocation simply involves dividing your portfolio into the assets that you want to hold, and putting a percentage of your money in each. We normally talk about five different asset classes: equities, bonds, property, gold and cash.
Gold acts as insurance hold about 5-10% of your money in that. Cash is great to have as dry powder', and, under some circumstances, it's the best asset class around. Bonds and equities often though not always perform differently to one another and so give you diversification benefits. And property is somewhere in the middle of those two it's sufficiently different to justify its own category.
Within these classes, you have to make more choices, of course. Which stocks do you want to own? Japanese? European? British? Small caps? Blue chips? 3D printing stocks? I'd suggest making these judgements based on what's cheap. Broadly speaking, the cheaper the market, the more money to have in it.
Once you've got your asset allocation, and you've divvied your money up, you make regular payments. That way you should be buying on the down' days as well as the up' days you're never investing right at the top of the market.
And once or maybe twice a year, you rebalance. If the value of the different parts of your portfolio has moved too far away from your original asset allocation, you can shift some money from the overweight parts to the underweight parts. That way, you automatically sell high' and buy low' which is what we're all meant to do, after all.
You'll find academic research that argues about exactly how and when to rebalance. People will swear blind that one theory or another would have produced an extra basis point (0.01%) here or there of a difference.
I think most of that research misses the point. Investing is about psychology as well as practicalities. Having a broadly sensible plan that you can have faith in is hugely important. It stops you making impulsive mistakes and it stops you from panicking.
Sitting with your portfolio all in cash, waiting to press the invest' button, is just plain stressful. You will never get your timing right, and even if you're uncannily accurate you will always regret the few percentage points of gain that you missed by being too early or too late.
And in any case, you won't be uncannily accurate. You'll turn bullish and bearish at exactly the wrong moments, wreak havoc on your portfolio, and give yourself a load of sleepless nights into the bargain.
So have a plan and stick to it. My colleague Tim Price is easily one of the most bearish people I know. Yet even he doesn't advocate holding your entire portfolio in cash. You can learn more about Tim's take on the world and what's currently keeping him up at night here.
