Are we investing wisely?

According to Bank of America (BoA) Private Bank, Millennials and Gen Z are more in alternative assets when it comes to investing. The definition of alternative assets has become broader to include anything money can buy (before it was limited to hedge funds and private investments in companies and commodities).

According to BoA, about 94% of wealthy Millennial and Gen Z investors are looking to invest in collectibles, and many of them already do, apparently because stocks and bonds don’t pay enough. They believe replacing stocks and bonds with more questionable stores of value, such as watches, sneakers and rare cars is sound investments.

Before I start dissecting the merits and demerits of the choice, let me start with the same for traditional asset classes i.e. stocks and bonds. They are liquid (relatively speaking), very easy to have a diversified portfolio (low-cost index funds/ETFs) and have proven historical returns (of course with volatility).

Alternate investments, on the other hand, are illiquid (relatively speaking), and extremely difficult to have a diversified portfolio (no practical way to buy the entire art or watch or sneaker market). But are they getting compensated enough by higher returns?

A traditional 60/40 portfolio where 60% is allocated to the S&P 500 Index and 40% to five-year Treasuries has returned 8.5% a year since 1926 including dividends.

The 60/40 portfolio had an annualised standard deviation – a common measure of volatility – of 11.4%. In a severe slump, a portfolio could be down two to three times its standard deviation, which means this portfolio was down about 30% at times before recovering and moving on to new highs. But there were always new highs.

According to a Natixis survey in 2023, investors expect 15.6% returns after inflation, an extremely unrealistic target of c.9% a year more than what financial advisors anticipates.

This explains rise of alternates with a ‘hope’ fuelled by some ‘hype’ about it.

The 60/40 portfolio’s average rolling 20-year returns across all interest rate environments since 1926 is closer to 8.9%. And it doesn’t require an army of fancy analysts and portfolio managers chasing the ‘best’ investments, just two or three index funds that track broad markets.

According to BoA, about a third of their portfolios are invested in alternatives that include collectibles and cryptocurrencies. The performance of these assets as a group is hard to track and even harder to anticipate.

Younger investors have another hurdle that’s worth mentioning: about a fifth of their savings sit in cash. It’s great for banks because it bolsters their balance sheets and feeds their loan business, but it’s a major drag on portfolios. Adding a 20% allocation to cash in an otherwise 60/40 portfolio – meaning 20% cash, 48% stocks and 32% bonds – would have generated 7.6% a year since 1926, almost a full percentage point less than a fully invested 60/40 portfolio.

Millennial and Gen Z investors told Bank of America that social media is their primary source for financial information and advice. Maybe it’s time to put down the dopamine dispenser and do some math.

Somnath Banerjee is head of investment management at Curmi and Partners Ltd.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.