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Stock/Bond Asset Allocation Strategy / Model / Chart / Risk Diversification / Bonds vs Stocks / Long Term Trader / Fund Trader / Institutional Asset Manager
Feb 17/07 - The world of asset allocation has a major impact on equity markets as funds flow into markets that are expected to benefit from a robust economy. As all assets are in competition with each other, money has a tendency to be allocated to those who are able to best invest it in growing sectors of the economy. This may not always be the case but in capital markets this is the general logic. Our interest at Marketpit.com is to allocate funds between the 10 year treasury and the S&P equity market. This is important as investors will have to decide to be conservative by buying bonds or to be expecting strong earnings from firms in the S&P. A stock could be considered a bond in perpetuity with an uncertain rate of return but the bond has a constant stream of income. The price of uncertainty is called the risk premium as investors do not want to hold stocks when they decline. Our strategy is to use the Stock vs Bonds analogy. It is a comparison of the Russell 2000 divided by the 10 year treasury and tells us the ratio of of the cost of debt vs equity risk. With a current ratio of 7.5 you could buy 7.5 units of bonds or 1 unit of the small cap index. It has moved between 3.5 and 7.8 since 1993. It made a high in early 2000 and is just now approaching the same level. What this means is that you could have invested in Bonds and have made the same return as the Russell 2000 over the last 7 years with much less volatility and a lot better sleep at night. However based on our analysis you would have been invested in equities since 2006 and have made double digit gains as compared to bonds over the last year.