A Modern Portfolio Allocation for 20-Year-Olds

Marcus Tullius Cicero, a statesman, lawyer, and philosopher in imperial Rome, once remarked that “Rashness belongs to youth; prudence to old age.” Substitute ‘risk-taking’ for ‘rashness’ and his observation serves as sage guidance for any young Swiss investor setting up a portfolio today.

Is 20 a Good Age To Invest?

The short answer is yes, and the reason is time. The longer your investment horizon, the more risk you can take. That may seem illogical when you consider that more time must also mean that a greater number of risk events can occur. With plenty of time available, however, investments can recover from the effects of those events; if your horizon is only a few years, that recovery might not have time to develop.

Imagine an investor who committed all the money to the Swiss Stock Market Index (SMI) at the onset of both the Dot-Com Bubble in the early 2000s and the Great Recession of 2007-2009. Both cases would make an investor wait for more than 5 years for an index to recover, yet a longer horizon and a little patience would allow one to ultimately capitalize on the growth trajectories that happened afterward.

Historical price of the Swiss Stock Market Index (in CHF)
Source: Yahoo Finance

Taking more risk often entails a relatively high allocation to equities, which have far outperformed bonds over the long term. The chart below illustrates the US experience, but it will have been substantially the same overall for any developed country. Equities have not only outperformed bonds over the long term, but the difference between them has also widened over the past decade.

Historical absolute returns on stocks and bonds over the past 100 years
Source: Longtermtrends

Regardless of age or risk appetite, most investors, however, do not like excessive volatility in their returns. That is why even young investors should hold bonds alongside equities, foregoing some performance in order to achieve a more consistent outcome that delivers fewer or smaller shocks.

The classic formula for this diversification is 60-40: 60% in equities, and 40% in bonds, maintained throughout the life of the portfolio. Although being rebalanced depending on age, even reputable investment management firms like Vanguard use a similar framework for their target-date funds allocation for 20-year-olds.

Vanguard target-date funds allocation based on years left to retirement age
Source: Vanguard

This approach stems from the work of Nobel laureates Harry Markowitz and William Sharpe and their Modern Portfolio Theory, published in 1952. They showed that the most effective balance between risk and return is achieved by diversification across the primary asset classes (stocks and bonds). As the rough distribution of equities and bonds in world markets was then about 60% and 40%, respectively, the 60-40 portfolio was born.

Over the long term, the strategy has worked well, delivering returns not far below those from equities alone but with significantly lower volatility. However, the course stops short of 2022, when the picture turned dark following the Russian invasion of Ukraine in February of that year.

While the chart below shows that even bigger setbacks have occurred in the past (i.e., 2008), this was the first time in recent memory that both bonds (signified by the red portion of the columns) and equities fell together. Diversified or not, almost every asset class was affected negatively.

Annual returns of the 60-40 portfolio
Source: Morningstar

Thankfully, this proved to be an aberration and, in 2023, the US-centric 60-40 portfolio gained nearly 18%, more than any of the established investment strategies. One swallow might not make a summer, but the signs are encouraging that the approach is sufficiently robust to ensure such setbacks will continue to be rare and transient.

Nonetheless, it would be better to ensure that even temporary turns like this, as well as the equity-only shocks of the Global Financial Crisis (2007-08) and the Dot-Com burst (2000-02), do the least possible damage to investment returns.

There are two solutions. The asset and geographic diversification, with the latter examined by Moonshot in 2023 research. That study revealed historic returns in Swiss markets have beaten those from international markets. Nevertheless, the Swiss market is relatively modest, with a market capitalization of USD 2.1 trillion (about the same as Germany or Taiwan). It would therefore not just be unwise to hold all of your eggs in such a little basket, but, very likely, it would also reduce returns and increase risk over time.

Learning From the Professionals

Many experts favor an international allocation of 40% or more. However, they are addressing US investors. Given the persistent strength of our currency, in addition to historically strong markets, Moonshot finds a more prudent weighting is not more than 20%. All of that should go into emerging markets.

Over the past two decades and more, emerging markets have delivered superior performance. On the other hand, as is evident from the chart below, these markets have also been much more volatile than world markets as a whole. In particular, they have been worse affected by financial and geopolitical crises. Yet, behind that evidently greater risk lies even greater possible reward. The 24 biggest emerging economies contributed more than half of the world's GDP in 2023 and accounted for no less than two-thirds of the growth over the past decade.

MSCI Emerging Markets vs. MSCI World indices performance since 2000s (in %)
Source: Longtermtrends, MSCI Inc.

Similar to a young investor, Swiss occupational pension funds have an extensive investment horizon that spans decades, making them a commendable model to follow. At nearly 50%, international equity exposure is far above our model.

There are two compelling reasons for this. First, these pension funds are of a different order of magnitude to the portfolio of a typical 20-year-old. At the end of 2023, they held USD 1.36 trillion in assets – more than half of the total market capitalization for all domestically listed companies. There’s just not enough capacity, therefore, for our pension funds to focus purely on domestic equities.

Swiss pension fund asset allocation history since 2003
Source: IPE

The second reason is that many of the largest Swiss corporate pension funds are sponsored by multinational companies, such as Roche, Nestlé, ABB, and leading banks. Many of their employees are located internationally. Their pensions will be paid not in Swiss francs, but in their local currencies. Accordingly, those overseas liabilities must be matched, as far as possible, by appropriate local assets in the pension schemes’ investment portfolios.

Alternative assets under management (in USD trillion)
Source: BlackRock

All of this unequivocally suggests that young investors should hold a certain portion of their investment assets in those markets, including real estate. Taking all of this information into consideration, Moonshot suggests a portfolio allocation matrix that a Swiss 20-year-old can build upon*. A small cash element has been added to provide for the major unplanned expenses that are bound to arise.

* The portfolio allocation does not represent an exhaustive or definitive approach, nor is it intended to be perceived or serve as such. Please keep in mind that investing inherently comes with risk, and Moonshot does not guarantee the results of either this strategy or any other strategy. It is important that investors conduct their own thorough due diligence and seek professional financial advice before making any investment decisions.

As a young investor, time may well be on your side, but that’s no reason to delay getting started and to make the most of your investment horizon.