That big market meltdown is out there, even if investors these days don't want to see it in a stock market that is now on year four of a bull run.
So says, Wall Street veteran Jared Dillian whose latest book - "The Awesome Portfolio: A Simple, Stress-Free Approach to Investing" - carries the not-so-popular message that investors need diversification. His message is to do that through equal-parts stocks, bonds, cash, gold and real estate.
"The average investor sees no need to diversify," he told MarketWatch in a recent interview. "If we were in the middle of a crash, the 'Awesome Portfolio' would probably be selling a lot more."
Dillian, founder and principal of commodity trading adviser Armington Capital and editor of The Daily Dirtnap newsletter, said investors haven't really experienced big drawdowns that would make them think about risk, even as they seem these days to be loading up.
"Excessive risk-taking is usually prevalent close to the top of the market, and we have more risk-taking than ever, and by the way, not just in the financial markets but also in things like sports betting and prediction markets," he said.
Those with 40-year investing careers will have witnessed a drawdown of 50% or more during that time, said Dillian, who spent seven years running the exchange-traded fund trading desk at Lehman Brothers before its demise in 2008. His 2011 book, "Street Freak: Money And Madness At Lehman Brothers," was based on that experience.
"When I started investing in 1998, I had two in the first 10 years, which really kind of calibrates your thinking about risk. The typical person out there doesn't think about risk. They don't have to, they haven't had to."
While early 2020 delivered the fastest bear market in history, the S&P 500 SPX recovered, and even a 20% drop for the index in 2022 doesn't stack up historically as that bad, he said.
What kind of pullback might wake up some investors? "I think once you get to 30%, if you have $500,000 in a 401(k) and that becomes $350,000, then you start to do some soul-searching. Because you say, what if it goes to $300,000, what if it goes to $250,000?"
His "Awesome Portfolio" only needs to be rebalanced once a year and "that cuts your volatility in half and eliminates your drawdowns," he says. Dillian added that even an investor who think they can take the stress of a bear market, will be unhappy and miserable "the whole time until you get back to the high-water mark."
Over the last 10 years, his Awesome Portfolio - 20% in equal parts to bonds, cash, gold, stock and real estate- has returned 9% a year, which he compares to the S&P 500's SPX 10% annual return over 100 years, 11% return over the past 54 years, and around 15% or more for the past 10 years.
He believes investors who can't live without that extra 1% return are too focused on the returns when they should be thinking first about the risk they'll accept to get that.
Dillian recommends ETFs for that portfolio starting with the Vanguard Morningstar Total Stock Market ETF VTI, which also gives investors exposure to underperforming small caps, which he thinks could turn around. The bond portion is Vanguard Total Bond Market ETF BND, which includes Treasurys, credit, mortgages, the F/m US Treasury 3 Month Bill Fund TBIL for cash, the iShares Gold Trust IAU and the Vanguard Real Estate ETF VNQ.
Dillian said he recently put a chunk of his own money into long-term bonds, acknowledging it's a bit of an unloved asset, to which he quoted from his book: "If you do not have something in your portfolio that you hate, you are not diversified."
Bond aversion, he said, is being driven by an "irrational fear" of inflation, which has been above the Fed's target for six years, but not by much, and a $2 trillion deficit that he doesn't think will be a forever problem.
"When I look at a 30-year Treasury bond at 5.33%, that looks pretty attractive to me," he said. Getting 5% for 10 years through a 10-year Treasury also has been historically pretty good, he added.
Like others, he harbors concerns about the artificial intelligence trade, notably big tech companies funding tech build-outs with billions in debt that will be hanging around for decades, to pay for chips that could be obsolete in three years.
"So that doesn't make a lot of sense, and that's been the one thing that scares me about this particular cycle is that a lot of it is debt-financed, and the funny thing about the dot-com bubble is that it because it was equity-financed there really weren't any consequences to the economy."
While the recession that followed the dot-com bust was mild, he's "much more worried this time around" about a possible debt crisis.
What investors need is a bit more imagination around what could go wrong. "I sit around and think of ways for things to go wrong, so I'm not fully invested in stocks, and I missed out on this big bull market in stocks. I've done pretty well over the past 10 or 15 years with the Awesome Portfolio or some variation of it, and there hasn't been a point where I've said to myself I'm scared about what's going to happen."
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