As we enter 2025, the US economy and corporate earnings remain strong, bond yields are hovering well above their pre-pandemic levels, and stock valuations sit at the higher end of their historical range. Yet, after more than a decade of steady growth, low inflation, and accommodative monetary policy, the ground has shifted. Given the evolving landscape, those looking to maximize their long-term return potential should revisit asset allocation’s first principles: ensuring your portfolio includes all the pillars of modern investing—not just stocks and bonds.
Go Beyond Hindsight to Strategic Foresight
Every portfolio tells a story. Each investor brings unique goals, spending habits, liquidity requirements, time horizons, and constraints to the table. Yet, at the heart of it all, the mission can be distilled into a simple, powerful directive: “Make the line on the portfolio value chart rise steadily up and to the right.”i
For risk-tolerant clients in life’s capital growth phase, that translates to aggressive positioning targeting the steepest appreciation possible. But for risk-averse clients in the spending phase, it means adopting a more defensive approach to ensure they can utilize their assets while stemming the rate of portfolio decline.
Sometimes, with the benefit of hindsight, clients will ask why we didn’t invest more in the top-performing asset—be it large-cap growth stocks, US stocks, bitcoin, or others. “Why can’t 100% of my portfolio be in that high-performing asset?” they wonder. The reality is, we don’t have the luxury of perfect foresight. The future is uncertain and can unfold in many ways, each with distinct implications for various assets.
The goal is to construct a portfolio that maintains or increases your wealth and remains resilient in the future. While some diversification can be achieved with minimal cost, beyond a certain point, it becomes a trade-off that must be considered more deliberately.
Alternative Investments: From Niche to Necessity
Many investors start with the classic “60/40” split—60% stocks and 40% bonds. Yet, today’s portfolios include a wider array of assets that have become essential to modern portfolios. These strategies typically bring different characteristics that enhance diversification. And often due to a tighter supply and higher demand dynamic compared to public markets, they tend to offer more attractive risk-adjusted returns. What’s more, the quality of the manager in these markets can have an outsized impact—and teaming up with top-tier managers can add significant value over time.
These types of assets are often referred to as “alternative” assets. A more fitting term might be “private” assets, distinguishing them from liquid public markets. But make no mistake, alternatives are no longer alternative. When accessed prudently, they are as coreii to a portfolio as stocks and bonds. They can enhance risk-adjusted returns, boost total returns, and help investors better meet their financial goals (Display 1).
Structural changes in today’s market have opened significant opportunities across the private investment landscape. The rapid rise in interest rates has led to a scarcity of liquidity, creating more upside potential for liquidity providers. Private lenders can capitalize on this constrained lending environment, especially amid the benign economic backdrop. What’s more, real estate valuations have dropped considerably, with many owners experiencing distress, presenting attractive openings. And the lack of private equity exits in recent years has also stoked a high demand for liquidity, favoring patient capital. We believe that investors who can handle illiquidity are well positioned to take advantage of these compelling long-term opportunities.
Tax Efficiency: The Secret to Higher Returns
Keep in mind, when it comes to investment opportunities, the returns you ultimately see are what’s left after taxes and fees. That’s why two of the three ways to enhance returns focus on these levers. Besides investing in assets with the strongest growth potential, minimizing tax liabilities and ensuring that any fees paid are both justified and competitive are vital.
That brings us to asset location. The impact of taxes on your returns can be significant, especially over the long haul. Depending on your level of wealth and the complexity of your financial situation, asset location can range from simply choosing between taxable accounts and retirement accounts to navigating a complex array of trusts, insurance vehicles, and other entities. This decision is partly made upfront but also depends on the types of assets you hold. For instance, yield-based assets are taxed at relatively high ordinary income rates, which can be substantial for those in high tax brackets. If you’re considering these types of assets, strategically placing them behind a tax shield can make a significant difference (Display 2).
Another effective strategy to blunt the tax impact? Proactive tax management. While some firms take a reactive approach, addressing taxes only at the end of the year, a continuous, year-round strategy works better, in our view. By collaborating closely with portfolio managers, we maximize the benefits of tax loss harvesting and consistently work to minimize tax drag, ensuring returns are optimized throughout the entire year.
Building Blocks for an Optimal Allocation
The optimal allocation is built by carefully selecting a mix of asset classes and deciding between active and passive strategies—including tailoring exposure to equities and fixed income based on factors like geography, company size, interest rate sensitivity, bond types, inflation protection, and credit risk. The aim is to boost risk-adjusted returns by tapping into different segments of the global economy and diverse return streams. This same approach applies to private markets, while also considering factors like duration of capital commitment and timing of capital calls. Importantly, choosing the right manager is essential in private markets, where track records tend to be consistent, and the range of outcomes can be wider.
Location, Allocation, Location
Getting your asset allocation—and location—right is the ball game for most investors. That’s why we work closely with clients to understand their goals, perspectives on money, constraints, concerns, and more. Those details help us design and implement a portfolio which will truly suit your needs.
While the traditional 60/40 allocation is often rumored to be “dead” in the press, we don’t agree. Instead, we simply find it moot for most investors. Why limit yourself to just two liquid asset classes in public markets when you can diversify with other asset classes that enhance your portfolio?
Bernstein combines the art and science of investing to make sure your assets are structured intelligently and allocated prudently to achieve your financial goals. There is no secret sauce to investing. But with the right tools, skills, and judgment, we can whip up a recipe for our clients’ investment success.
- Matthew D. Palazzolo
- Senior National Director, Investment Insights—Investment Strategy Group
- Christopher Brigham
- Senior Research Analyst—Investment Strategy Group
i This paraphrases what one of our mentors, a top-performing hedge fund investor, told us our job was as investors
ii You’ll notice we use the word “core” at multiple points throughout this piece and that it has several different meanings inside the investment industry. That’s an unfortunate consequence of our industry being more creative in finding things to invest in than we are in naming things. At different points, we’ll talk about core vs. surplus capital as well as a core-satellite approach to allocation. Outside of this blog, some strategies are also described or named as core or noncore, which usually has more to do with the segment of the market they’re investing in or the style in which they’re investing.