An Ode to ‘Conservative’ Investments

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FINANCIAL RECKONINGS

By Clark Troy
Correspondent

After a couple of years in which money at times seemed almost literally to grow on trees, 2022 is proving to be a much less fun year financially in every way imaginable. Central banks around the world have been raising interest rates to combat an inflation that remains stubbornly persistent for many reasons, not least of which is the fact that some of its key drivers — the supply chain challenges exacerbated by China’s zero-COVID strategy and the impact on global food and petroleum prices of Russia’s war in Ukraine — are not at all susceptible to many of the tools in the central banker’s toolbox.

So lots of people are a bit on edge, and understandably so.

In conversation the other day, a client referred to a target date fund as “conservative,” a statement which surprised me, given that he had an MBA. In general, fund managers build target date funds with asset allocations considered appropriate for one’s investment horizon. If the target is a child who’s going to college in 10 years or someone who plans to retire in 15, the fund should contain a mix of asset classes (stocks of various types – large and small companies, domestic and foreign, plus bonds and sometimes real estate investment trusts) considered to have the optimal risk/return. These funds typically adjust their allocations as their “target date” approaches and, as they have evolved, more of them continue to adjust their allocations even after it has passed.

A target date fund should therefore never be either “conservative” or “aggressive.” Like Goldilocks eating the small bear’s porridge, it should be “just right” for its owner, especially when held within a tax-preferred account like a 401k, 403b, or IRA – which protects one from unexpectedly large capital gains distributions which sometimes are distributed out of target date funds towards the end of a year.

Similarly, index funds — which replicate rather than seek to outperform indices of stocks and other instruments (most famously the S&P 500) are on occasion referred to as “conservative” investments. While index funds might seem to have a certain methodological or epistemological conservatism to them in that they try to offer investors the benefits of broad diversification without pursuing the “idiosyncratic” risks of individual securities or portfolios made up of small numbers of them, it’s hard to argue that index funds are intrinsically conservative. Over the roughly nine decades of its existence, the S&P 500 has had a mean return of about 10% with a standard deviation of 19. Which is to say that about two-thirds of the time it returns somewhere between negative 9% and 29%, and that 95% of the time it returns between negative 28% and 48%. That’s a pretty big spread. Which is why most people diversify beyond just stocks into other asset classes – primarily bonds — which in most years (though not 2022) provide substantial protection against variations in stock prices.

I suspect that there’s some mild gender-coding going on here. The fund/asset management industry wants to portray target date funds and index funds as “conservative” (i.e., ”wimpy”) to contrast them with the more masculine “risk-takers” who pick individual securities or actively managed funds so they can display “alpha” and “win” by beating other people with their superior returns.

In fact, what’s important to most people is that they have enough money to fund their financial goals (buying a home, sending a kid to college, enjoying vacations and retirement), not that they have more money than their neighbors. After all, no one puts their lifelong rate of return on their gravestone. There’s more than enough risk and return for most people in the markets themselves.


Clark Troy was born in Durham and educated in the Chapel Hill-Carrboro City Schools, then elsewhere. He is a financial planner at Red Reef Advisors and may be reached at clark.troy@redreefadvisors.com. When not working, he reads, plays sports, naps, drinks coffee and plays guitar, not necessarily in that order.

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