re allocate equity

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Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing

Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn them? Through ordinary, real-life experiences that have nothing to do with the stock market.

For example, have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses. And when it’s sunny, the reverse is true. By selling both items - in other words, by diversifying the product line - the vendor can reduce the risk of losing money on any given day.

If that makes sense, you’ve got a great start on understanding asset allocation and diversification. This publication will cover those topics more fully and will also discuss the importance of rebalancing from time to time.

Let’s begin by looking at asset allocation.

Asset Allocation 101

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.

Time Horizon

Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets. By contrast, an investor saving up for a teenager’s college education would likely take on less risk because he or she has a shorter time horizon.

Risk Tolerance

Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. In the words of the famous saying, conservative investors keep a “bird in the hand,” while aggressive investors seek “two in the bush.”

Risk versus Reward

When it comes to investing, risk and reward are inextricably entwined. You’ve probably heard the phrase “no pain, no gain” - those words come close to summing up the relationship between risk and reward. Don’t let anyone tell you otherwise. All investments involve some degree of risk. If you intend to purchase securities - such as stocks, bonds, or mutual funds - it’s important that you understand before you invest that you could lose some or all of your money.

The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals.

Investment Choices

While the SEC cannot recommend any particular investment product, you should know that a vast array of investment products exists - including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds, money market funds, and U.S. Treasury securities.

For many financial goals, investing in a mix of stocks, bonds, and cash can be a good strategy. Let’s take a closer look at the characteristics of the three major asset categories.

Stocks have historically had the greatest risk and highest returns among the three major asset categories. As an asset category, stocks are a portfolio’s “heavy hitter,” offering the greatest potential for growth. Stocks hit home runs, but also strike out. The volatility of stocks makes them a very risky investment in the short term. Large company stocks as a group, for example, have lost money on average about one out of every three years. And sometimes the losses have been quite dramatic. But investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.

Bonds are generally less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings because the reduced risk of holding more bonds would be attractive to the investor despite their lower potential for growth. You should keep in mind that certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk.

Cash and cash equivalents - such as savings deposits, certificates of deposit, treasury bills, money market deposit accounts, and money market funds - are the safest investments, but offer the lowest return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low. The federal government guarantees many investments in cash equivalents. Investment losses in non-guaranteed cash equivalents do occur, but infrequently. The principal concern for investors investing in cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time.

Stocks, bonds, and cash are the most common asset categories. These are the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. But other asset categories - including real estate, precious metals and other commodities, and private equity - also exist, and some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.

Why Asset Allocation Is So Important

By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.

The Magic of Diversification

The practice of spreading money among different investments to reduce risk is known as diversification. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.

In addition, asset allocation is important because it has a major impact on whether you will meet your financial goal. If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance, would be inappropriate for a short-term goal, such as saving for a family’s summer vacation.

How to Get Started

Determining the appropriate asset allocation model for a financial goal is a complicated task. Basically, you’re trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk you can live with. As you get closer to meeting your goal, you’ll need to be able to adjust the mix of assets.

If you understand your time horizon and risk tolerance - and have some investing experience - you may feel comfortable creating your own asset allocation model. “How to” books on investing often discuss general “rules of thumb,” and various online resources can help you with your decision. For example, although the SEC cannot endorse any particular formula or methodology, the Iowa Public Employees Retirement System (www.ipers.org) offers an online asset allocation calculator. In the end, you’ll be making a very personal choice. There is no single asset allocation model that is right for every financial goal. You’ll need to use the one that is right for you.

Some financial experts believe that determining your asset allocation is the most important decision that you’ll make with respect to your investments - that it’s even more important than the individual investments you buy. With that in mind, you may want to consider asking a financial professional to help you determine your initial asset allocation and suggest adjustments for the future. But before you hire anyone to help you with these enormously important decisions, be sure to do a thorough check of his or her credentials and disciplinary history.

The Connection Between Asset Allocation and Diversification

Diversification is a strategy that can be neatly summed up by the timeless adage, “don’t put all your eggs in one basket.” The strategy involves spreading your money among various investments in the hope that if one investment loses money, the other investments will more than make up for those losses.

Many investors use asset allocation as a way to diversify their investments among asset categories. But other investors deliberately do not. For example, investing entirely in stock, in the case of a twenty-five year-old investing for retirement, or investing entirely in cash equivalents, in the case of a family saving for the down payment on a house, might be reasonable asset allocation strategies under certain circumstances. But neither strategy attempts to reduce risk by holding different types of asset categories. So choosing an asset allocation model won’t necessarily diversify your portfolio. Whether your portfolio is diversified will depend on how you spread the money in your portfolio among different types of investments.

Diversification 101

A diversified portfolio should be diversified at two levels: between asset categories and within asset categories. So in addition to allocating your investments among stocks, bonds, cash equivalents, and possibly other asset categories, you’ll also need to spread out your investments within each asset category. The key is to identify investments in segments of each asset category that may perform differently under different market conditions.

One way of diversifying your investments within an asset category is to identify and invest in a wide range of companies and industry sectors. But the stock portion of your investment portfolio won’t be diversified, for example, if you only invest in only four or five individual stocks. You’ll need at least a dozen carefully selected individual stocks to be truly diversified.

Because achieving diversification can be so challenging, some investors may find it easier to diversify within each asset category through the ownership of mutual funds rather than through individual investments from each asset category. A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, and other financial instruments. Mutual funds make it easy for investors to own a small portion of many investments. A total stock market index fund, for example, owns stock in thousands of companies. That’s a lot of diversification for one investment!

Be aware, however, that a mutual fund investment doesn’t necessarily provide instant diversification, especially if the fund focuses on only one particular industry sector. If you invest in narrowly focused mutual funds, you may need to invest in more than one mutual fund to get the diversification you seek. Within asset categories, that may mean considering, for instance, large company stock funds as well as some small company and international stock funds. Between asset categories, that may mean considering stock funds, bond funds, and money market funds. Of course, as you add more investments to your portfolio, you’ll likely pay additional fees and expenses, which will, in turn, lower your investment returns. So you’ll need to consider these costs when deciding the best way to diversify your portfolio.

Changing Your Asset Allocation

The most common reason for changing your asset allocation is a change in your time horizon. In other words, as you get closer to your investment goal, you’ll likely need to change your asset allocation. For example, most people investing for retirement hold less stock and more bonds and cash equivalents as they get closer to retirement age. You may also need to change your asset allocation if there is a change in your risk tolerance, financial situation, or the financial goal itself.

But savvy investors typically do not change their asset allocation based on the relative performance of asset categories - for example, increasing the proportion of stocks in one’s portfolio when the stock market is hot. Instead, that’s when they “rebalance” their portfolios.

Rebalancing 101

Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time some of your investments may become out of alignment with your investment goals. You’ll find that some of your investments will grow faster than others. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.

For example, let’s say you determined that stock investments should represent 60% of your portfolio. But after a recent stock market increase, stock investments represent 80% of your portfolio. You’ll need to either sell some of your stock investments or purchase investments from an under-weighted asset category in order to reestablish your original asset allocation mix.

When you rebalance, you’ll also need to review the investments within each asset allocation category. If any of these investments are out of alignment with your investment goals, you’ll need to make changes to bring them back to their original allocation within the asset category.

There are basically three different ways you can rebalance your portfolio:

• You can sell off investments from over-weighted asset categories and use the proceeds to purchase investments for under-weighted asset categories.
• You can purchase new investments for under-weighted asset categories.
• If you are making continuous contributions to the portfolio, you can alter your contributions so that more investments go to under-weighted asset categories until your portfolio is back into balance.

Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use will trigger transaction fees or tax consequences. Your financial professional or tax adviser can help you identify ways that you can minimize these potential costs.

When to Consider Rebalancing

You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing.

Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you’ve identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.

Where to Find More Information

For more information on investing wisely and avoiding costly mistakes, please visit the Investor Information section of the SEC’s website. You also can learn more about several investment topics, including asset allocation, diversification and rebalancing in the context of saving for retirement by visiting FINRA’s Smart 401(k) Investing website as well as the Department of Labor’s Employee Benefits Security Administration website.

You can find out more about your risk tolerance by completing free online questionnaires available on numerous websites maintained by investment publications, mutual fund companies, and other financial professionals. Some of the websites will even estimate asset allocations based on responses to the questionnaires. While the suggested asset allocations may be a useful starting point for determining an appropriate allocation for a particular goal, investors should keep in mind that the results may be biased towards financial products or services sold by companies or individuals maintaining the websites.

Once you’ve started investing, you’ll typically have access to online resources that can help you manage your portfolio. The websites of many mutual fund companies, for example, give customers the ability to run a “portfolio analysis” of their investments. The results of a portfolio analysis can help you analyze your asset allocation, determine whether your investments are diversified, and decide whether you need to rebalance your portfolio.

Questions or Complaints?

We want to hear from you if you encounter a problem with a financial professional or have a complaint concerning a mutual fund or public company. Please send us your complaint using our online Complaint Center .

You can also reach us by regular mail at:

Securities and Exchange Commission Office of Investor Education and Assistance 100 F Street, NE Washington, DC 20549-0213

The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.

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How To Calculate How Much Home Equity You Have (2023)

Katie Oelker is a freelance personal finance writer specializing in insurance, credit cards, and travel rewards. She has written for Business Insider, InvestingAnswers, Investopedia, The Balance, and VeryWell. With a BBA in business economics and management and a Master’s teaching degree, Katie loves breaking down complex financial concepts into digestible information all readers can understand. When not working, Katie loves to spend time with her family, cooking, enjoying the great outdoors, and planning her next adventure.

Andrew Dunn is a veteran journalist with more than a decade of experience in the business and finance arena. Before joining our team, Andrew was a reporter and editor at North Carolina news organizations including The Charlotte Observer and the StarNews in Wilmington. In those roles, his work was cited numerous times by the North Carolina Press Association and the Society of Business Editors and Writers. Andrew completed the business journalism certificate program from the University of North Carolina at Chapel Hill.

Equity is the portion of your home you own outright, and you might need to know how to calculate it if you want to borrow money, sell your house or refinance the mortgage. 

The equation is simple: Subtract your mortgage balance from your home’s appraised value. The more complicated parts might be tracking down that balance, your home’s current value, and figuring out how much of your equity you may tap for a home renovation, emergency expense or other bills. 

We at the MarketWatch Guides team will walk you through each step and the pros and cons of each.

What Is Home Equity?

Step-by-step guide to calculating home equity, how to borrow with your home equity, pros and cons of borrowing with your home equity, how to increase home equity, the bottom line.

Home equity is the difference between your home’s value and any debts tied to it, including your mortgage. You probably began building equity before the real estate agent even handed over the keys, thanks to a down payment . As you made mortgage payments, that equity grew, slowly at first and then faster as more of your payment went to the loan’s principal instead of the interest.

At the same time, your home’s value may have increased as many parts of the U.S. are experiencing rising home prices . This type of positive appreciation increases your equity as well.  

One of the advantages of building equity in your home is the opportunity to borrow against it. This allows you to pay off debt, make home improvements and finance other purchases.

Now that you understand how home equity works at a high level, you’ll need a few pieces of information to calculate home equity for your own situation.

Step 1: Determine Your Home’s Current Market Value

You can get an idea of your home’s worth through online home valuation tools on websites like Zillow, Redfin, and other mortgage or real estate sites. Enter your address, and the tools will give you an idea of your home’s fair market value. 

However, these results aren’t the same as a professional appraisal or independent assessment of your property’s value. Finding a professional appraiser can be done through a trusted mortgage lender or real estate agent. 

Step 2: Calculate Your Outstanding Mortgage Balance

When looking for your outstanding mortgage balance, find your most recent mortgage statement. You may be able to get this through your lender’s online portal or a recent paper statement, depending on your communication preferences. 

You should also be able to contact your mortgage broker or lender by email or over the phone for an updated amount. 

Step 3: Apply the Home Equity Formula

Now that you have your home’s current market value and outstanding mortgage balance, subtract the outstanding balance from the current market value. 

For example, if the value is $495,000 and you owe $330,000, you hold $165,000 in home equity. However, that doesn’t mean you’ll be able to tap all $165,000 if you want to borrow money to replace the roof or pay a tuition bill. A lender will look at this figure and your financial profile to determine that amount.

If you’d like to borrow against your home’s equity, one of the first things a lender will look at is your loan-to-value ratio (LTV). 

Your lender will do the math for you, but you can find this percentage yourself. Divide your mortgage balance by the appraised value and multiply it by 100. Using the example above, $330,000 divided by $495,000 is .66 for an LTV of 66%. Put another way, you have about 34% equity in your home, which may put you in a good position to tap your home’s equity. Two of the most popular ways to do that are through a home equity loan or home equity line of credit (HELOC). 

Home Equity Loans

A home equity loan is a lump sum of money repaid over a fixed period, typically in monthly payments up to 30 years. When considering your loan application, lenders will probably look at your credit score, income and LTV. Once approved, you may be able to borrow up to 80% of the equity in your home. Using the example above, if you have $165,000 in home equity, you could borrow up to 80% or $132,000. 

You could use that cash to repair or renovate a home or pay off high-interest debt, medical expenses, college tuition, or other expenses. If you fail to repay the loan on time, the lender might be able to foreclose on it.

Home Equity Lines of Credit (HELOCs)

Like a home equity loan, a home equity line of credit is secured by your home, which means you once again risk foreclosure if you cannot repay it. A big difference is that HELOCs give you a line of credit you may draw down as needed. Payments typically begin when the draw period ends, though you will probably have to make smaller, interest-only payments in the meantime.  

A home equity loan may be more helpful if you need a specific amount and prefer a fixed interest rate. HELOCs usually have variable rates, meaning your payments might fluctuate over time. No matter which you choose, compare lenders to find the lowest rates and fees. Make sure you understand their terms, rates, and fees. 

Homeowners who tap their home equity might be able to pay off debt or afford home renovations without dipping into their savings, using a credit card, or taking out a personal loan, but it also has drawbacks. Below is a list of some of the pros and cons of borrowing against home equity:

• Ability to make improvements or pay off higher-interest debt
• Lower rates than credit cards or personal loans
• Interest may be tax-deductible if used for home improvements
• If you default on payments, the lender might foreclose.
• Potential fees, including the cost of an appraisal and other closing costs
• Lower sale proceeds if you decide to sell your home before repaying the loan or HELOC

If a lender declines your home equity loan or HELOC application it might be because you haven’t built enough home equity to qualify. Increasing home equity takes time, but there are steps you can take, including improving your home’s value and paying extra on your mortgage. We’ll take a closer look at each method. 

Home Improvement Projects

Conducting home improvements, renovations or repairs has the potential to increase the value of your home, and when your home’s value increases, the equity calculation changes. 

Some home improvement projects yield little increase in home value, while other improvements greatly increase it. Exterior home improvements, such as new siding, roofing or a new garage door, typically have a high return on investment. A small kitchen remodel and adding or refinishing hardwood floors can also similarly affect home values. 

Paying Down Your Mortgage

By making an extra mortgage payment a month (or annually, even) and applying it toward the loan’s principal, you can effectively knock years off the note and save yourself thousands in interest. For example, if you owe $330,000 on the mortgage you took out five years ago at 6% interest and put an extra $500 a month toward it, you could shave more than 10 years and $100,000 in interest. 

Of course, if you have that kind of cash, you might not need to borrow, but even a smaller amount builds equity faster and saves you in the long run.

Calculating home equity is straightforward once you understand what information you need. With your home’s value and the mortgage balance, you can get a rough estimate of your home equity. For a more accurate figure, your home might need a professional appraisal. This appraised amount is what lenders use to determine if you’re eligible for a home equity loan or a HELOC. Accepting one means weighing the pros and cons of each and deciding what makes the most sense for your financial goals. 

Frequently Asked Questions About Calculating Home Equity

Is it a good idea to take equity out of your house.

That depends. Accessing home equity might help you make home improvements or pay off higher-interest debt. In these instances, the relatively low interest rates when borrowing against equity could be worth it, but it also comes with risks. If you default on your payments, you risk foreclosure. Anyone considering it should weigh the pros and cons.

Can you pull equity out of your home without refinancing?

Yes. A home equity loan and a home equity line of credit (HELOC) allow you to access your equity without refinancing.

What is the most equity you can take out of your house?

While the exact amount depends on factors such as your income, credit history and home value, most lenders will limit funds to 85% of your home equity while others may have even lower thresholds.

What is the cheapest way to get equity out of your house?

The cheapest way to get equity out of your home depends on your exact interest rate and fees, but in general, a home equity line of credit only charges interest on what you borrow. It’s possible to find no-fee HELOCs. Remember, a lender can take possession of your home if you miss payments.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.

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Why you should use home equity with interest rates on pause

By Angelica Leicht

November 3, 2023 / 11:28 AM EDT / CBS News

Interest rates have increased exponentially over the last 18 months, and that trend is due, in large part, to the Federal Reserve raising interest rates nearly a dozen times  to try and get inflation under control . And, while inflation has indeed cooled compared to what it was this time last year, the recent rate hikes have also resulted in much higher borrowing costs . This has led many potential borrowers to wait on the sidelines in hopes that rates will decline in the near future.

But so far, no rate drops have occurred, and the cost of borrowing remains a lot higher than it was just a couple of years ago. It's not all bad news on the interest rate front, though. The Fed met again earlier this week and, rather than hike rates again, it opted to temporarily pause rate hikes — despite inflation hovering above the target rate of 2%. 

The Fed's decision to pause rate hikes is welcome news for most borrowers — whether they want to purchase a home with a mortgage , borrow money with a personal loan or tap into their home's equity with a home equity loan . And, if you're a current homeowner with equity in your home, there are a few good reasons why using home equity when interest rates are on pause can be a wise financial move.

Explore your top home equity loan options here to see how it could benefit you .

There are a few different reasons it makes sense to use your home equity while interest rates are paused, including:

To lock in a favorable rate

One of the primary benefits of borrowing against your home equity when interest rates are on pause is the potential for lower borrowing costs. Since interest rates are temporarily stable, taking out a home equity loan or line of credit can be significantly cheaper than it would be in a rising interest rate environment. And, lower interest costs mean that you can access the money you need at a lower cost, ultimately saving you money in the long run.

So, homeowners may want to consider locking in a favorable interest rate now. By doing so, you can secure a low-cost financing option for your immediate needs, whether it's for home improvements, debt consolidation or other financial goals. 

Find out more about the home equity rates you could qualify for here .

To avoid the impact of future rate hikes

While Fed rate hikes are temporarily paused, it's essential to acknowledge that this pause may not last indefinitely. In fact, many experts believe that there will be at least one more rate hike in the near future. After all, while inflation has cooled compared to last year, it's still higher than it should be — and there's a strong possibility that the Fed will need to increase its benchmark rate at least once more to get it under control. 

Another rate hike by the central bank could lead to higher borrowing costs for various forms of credit, including home equity loans. By using your home equity to access funds at the current interest rates , you can protect yourself from the potential impact of rising borrowing costs in the future. This can translate into significant savings over the life of your loan or line of credit.

For access to affordable funds

The funds accessed through a home equity loan can be used for various purposes , such as home improvements, debt consolidation, education expenses or even investing in other opportunities. The affordability of these funds makes it a financially savvy move to leverage your home equity for such purposes — and when compared to other types of lending products, like credit cards, the average rates are much lower. 

For example, the average credit card rate hovers well above 20% right now, but the average home equity loan rate is 8.94% as of November 3, 2023. You could see big savings by lowering your interest rate by even a fraction of a point — and a double-digit difference in borrowing rates, like the difference between credit cards and home equity loans, can equate to a significantly more affordable loan . 

For long-term planning

Incorporating your long-term financial goals into the equation is also crucial. By taking advantage of favorable rates now, you can position yourself more strategically for the future . This might involve using home equity to invest in assets that have the potential to generate returns, ultimately building wealth over time.

For example, with interest rates on pause, some individuals may consider using their home equity to invest in opportunities that have the potential to yield a higher return than the cost of borrowing. Whether it's investing in stocks, starting a business or purchasing income-generating assets, using home equity can be a strategic way to diversify your investment portfolio and make your money work harder for you.

The bottom line

At a time when economic and financial uncertainties are common, the pause in interest rates presents homeowners with a unique opportunity to leverage their home equity for various financial goals. Lower borrowing costs, access to affordable funds, flexibility and potential tax benefits make using home equity a wise financial move. However, it's essential to exercise caution and ensure that you have a well-thought-out plan in place when tapping into your home equity to maximize its potential benefits while managing the associated risks. 

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The Denominator Effect – How Volatility in the Public Markets Has Impacted Fundraising in the Private Markets

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The Denominator Effect occurs when the value of one portion of a portfolio decreases drastically and pulls down the overall value of the portfolio. As a result, any segments of portfolio, which did not decrease in value, now represent a large percent of the overall pie.  

In and of itself, the Denominator Effect does not negatively impact those other segments of the portfolio, but in the context of the institutional investing, when the Denominator Effect hits, it is the private markets holdings of LP investors that generally increase in terms of portfolio sizing. This is of course because valuations for private markets funds are calculated on a lag compared to the LP’s public markets holdings, which are essentially valued in real-time. 

As the public markets slip into a bear market pension plan investors have seen significant impacts to the valuations of their public markets holdings and as a result, their private markets holdings have ticked up as an overall percentage of their respective portfolios. 

While the public markets holdings of pension plans will likely recover in value over time, in the short-term, the Denominator Effect has the potential to impact fundraising and new commitment activity to private markets fund managers. Stringent governance and target allocation policies mean that LPs who are now over-allocated to the private markets cannot make new commitments that would push them farther beyond those limits. 

Who’s feeling the pressure from the Denominator Effect?  

These documents, sourced from Nasdaq eVestment’s  Market Lens platform , highlights how three LPs are currently monitoring the impact of the Denominator Effect on their portfolios and how they are reacting. 

State of Wisconsin Investment Board (SWIB) 

In an update from February 22 2022, SWIB indicated that in December 2021 their private equity and private debt target exposure was updated to 12% with an acceptable range of 9 – 15%. Just one month later in January 2022 as a result of public market losses and the Denominator Effect, their private equity and private debt allocation was less than 1% from the upper end of their newly set acceptable range. As a result their consultant NEPC has recommended a short-term increase of the acceptable range to 17% as well as a  “deep-dive review of asset class ranges as part of the 2022 asset allocation process.”

Ohio Bureau of Workers’ Compensation

RVK, the consultant for Ohio Bureau of Workers’ Compensation has recommended that the pension plan adopt a temporary waiver for rebalancing their real estate assets.  “ The surge in the real estate allocation as a percentage of total SIF assets is  not a result of inappropriate investment de cisions. It is a function of two factors:  1)  The general and comprehensive decline in the global stock and bond markets, and  2)  The success of the BWC’s real estate investments since inception.”

New York City Fire 

Liquidity reports for New York City Fire feature Denominator Effect analysis that measures the illiquidity ratio of their portfolio as of the current quarter end and 1 and 2 year time horizons to model the effect of a 33% decline in portfolio value.

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Diversifying With Real Estate and Infrastructure

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

Investing in something other than stocks and bonds is undoubtedly a significant element of asset allocation . Two optimal alternative investments are real estate (land and structures on it— real property , in other words) and infrastructure (vital physical networks that industries, individuals, and regions need, like transportation, communication, sewage, water, and electric systems).

Both real estate and infrastructure constitute attractive investments for risk-averse investors, especially during bear markets . There are similarities and differences between the two, and you can construct a truly optimal portfolio by fully exploiting them. 

Key Takeaways

• A well-diversified portfolio should contain investments in a wide variety of asset classes, including real estate and infrastructure projects.
• Like real estate, infrastructure is a long-duration asset that produces provides diversification and generates income.
• Real estate investments and infrastructure are often bundled together in securities such as REITs or mutual funds that target these particular sectors.
• The optimal amount to invest in real estate and infrastructure will vary on an individual basis by investment goals, time horizon, and risk profile.

Diversification Through Real Estate and Infrastructure

The diversification benefits of direct and indirect  real estate investments are well known, and diversification's role in institutional portfolios has been investigated extensively. The different correlations to those of stocks and bonds are extremely helpful for avoiding portfolio volatility. Rental of residential real estate is a defensive sector. People will continue to rent their place of residence even if there is a recession or a depression.

Infrastructure has received relatively less attention, along with other alternative assets such as commodities and private equity, in the past. But with the Biden administration voicing its support for large infrastructure overhaul in the U.S., investors should take advantage of this potential to diversify more effectively than ever and in an extremely promising sector . In fact, infrastructure has become a focus of attention and found its way into institutional portfolios, and, to a lesser extent, private ones.

What makes infrastructure so appealing is that it seems quite similar to direct real estate in terms of big lot sizes and illiquidity, but also offers general stability and stable cash flows .

For the last 20 or 30 years, the area of investing in infrastructure had been the dominion of large pension funds and sovereign wealth groups. But now an increasing number of publicly traded companies are targeting this area, opening up investment options for individual investors. Real estate and infrastructure are often bundled together in securities such as real estate investment trust  (REIT, master limited partnerships (MLPs), or mutual funds that target these particular sectors.

The number of public companies offering exposure to infrastructure that have been identified by Todd Briddell, President and CEO of CenterSquare Investment Management.

Portfolio Optimization With Real Estate and Infrastructure

From an asset-allocation standpoint, research on infrastructure lags behind that of real estate, but researchers Tobias Dechant, Konrad Finkenzeller, and Wolfgang Schäfers of the University of Regensburg International Real Estate Business School have attempted to bridge the gap (no pun intended). Their paper published in the Journal of Property Investment & Finance demonstrates that direct infrastructure investment is an important element of portfolio diversification  and that firms tend to over-allocate to real estate if they do not also invest in infrastructure, which the authors consider a separate asset class .

There is considerable variation in the recommended, relative amounts that should be invested in real estate and infrastructure. The maximum total amount usually recommended for allocations is about 25% to 40% of total net worth. But the range extends from 10% to as high as 70% (mainly in real estate), depending on the time frame, state of the markets, and the methods used to derive the optimum. Efficient allocations in practice depend on numerous factors and parameters, and no specific mix proves to be consistently superior.

The blend of real estate and infrastructure is also controversial, but one study by the Norwegian Government Pension Fund Global suggests a maximum portfolio weighting of about 10% is sufficient for each. In crisis periods, this can be three or even four times higher.

Another important finding is that real estate and infrastructure may be more useful in terms of alleviating risk (the classic aim of diversification) than through actual returns . Given the controversy on effective asset allocation and the turbulence in real estate markets, this is a major issue. The latter highlights the benefits of using not only real estate but also infrastructure.

Also significant is the revelation that the targeted rate of return impacts the appropriate level of real estate. Investors with higher portfolio return targets (who wish to earn more, but with more risk), may wish to devote less to real estate and infrastructure. This depends a lot on the state of these markets in relation to the equity markets in terms of whether the latter is in an upward or downward phase.

Both real estate investment and infrastructure can play a vital role in optimizing portfolios. The exact allocations to real estate and infrastructure depend on various parameters. Apart from the expected rate of portfolio return mentioned above, there is also the issue of how risk is defined. Other relevant factors include attitudes towards infrastructure in general, and how this relates to other alternative investments.

In practice, these allocation decisions are complex, and higher or lower optima are therefore possible for different investors at different times. If there is one thing that remains the top priority for all investors—especially risk-averse ones—it's having a well-diversified portfolio.

The White House. " FACT SHEET: President Biden Announces Support for the Bipartisan Infrastructure Framework ."

Wharton - Samuel Zell & Robert Lurie Real Estate Center. " Infrastructure vs. Real Estate Investing ."

Konrad Finkenzeller, Tobias Dechant, and Wolfgang Schäfers. "Infrastructure: a new dimension of real estate? An asset allocation analysis."Journal of Property Investment & Finance, vol. 28, issue 4, 2010, pages 263-274.

Delta Wealth Advisors. " What Percentage of Net Worth Should Be in Real Estate? "

Columbia Business School. " A review of real estate and infrastructure investments by the Norwegian Government Pension Fund Global (GPFG) ," Page 6.

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The Proper Asset Allocation Of Stocks And Bonds By Age

The proper asset allocation of stocks and bonds by age is important to achieve financial freedom. If you allocate too much to stocks the year before you want to retire and the stock market collapses, then you're screwed. If you allocate too much to bonds over your career, you might not be able to build enough capital to retire at all.

Just know the proper asset allocation is different for everyone. There is no “correct” asset allocation because everybody has different earnings power, different risk tolerances , and different needs. We are all at different stages of our financial lives. Therefore, know thyself!

Although there might not be a proper asset allocation, there is, however, an optimal asset allocation by age I'd like to share in this post. An optimal asset allocation is where you have greater than a 70% chance of achieving your financial objectives. My recommended asset allocation should be relevant for most financial circumstances.

As someone who worked in finance for 13 years, got my MBA, and has written over 2,500 personal finance articles on Financial Samurai since 2009, the topic of asset allocation is one of the most important.

Those who do not have a risk-appropriate asset allocation often lose more than they should. And when you lose too much money, you ultimately lose time, the most valuable asset of all.

Proper Asset Allocation And Risk Tolerance

Your asset allocation between stocks and bonds first depends on your risk tolerance . Are you risk averse, moderate, or risk loving? Are young and full of energy? Or are you old and tired as hell?

I'm personally extremely tired due to raising two kids during a pandemic. Therefore, I'm relatively conservative. Besides, after such a huge run in the stock market, I'd like to keep most of the gains during the next correction.

Your asset allocation also depends on the importance of your specific market portfolio. For example, most would probably treat their 401K or IRA as a vital part of their retirement strategy. For most, these retirement accounts will become their largest investment portfolios.

However, those who have taxable investment accounts , rental properties , and alternative assets may not find their stock and bond portfolio as important.

For example, I have roughly 50% of my net worth in real estate because I prefer owning a hard asset that is less volatile, provides shelter, and produces rental income. I then have roughly 30% of my net worth in equities. Volatility is something I do not like.

Finally, the proper asset allocation of stocks and bonds depends on your overall net worth composition . The smaller your stocks and bonds portfolio as a percentage of your overall net worth, the more aggressive your portfolio can be in stocks.

The Proper Asset Allocation Of Stocks And Bonds Analyzed

I ran my current 401K through Empower to see what they thought about what my proper asset allocation is. You should do the same thing since it's free. To no surprise, the below chart is what they came back with.

I essentially have too much concentration risk in stocks and am underinvested in bonds based on the “conventional” asset allocation model for someone my age. To run the same analysis on Personal Capital, simply click the “Investment Checkup” link under the “Investing” tab.

I am going to provide you with five recommended asset allocation models to fit everyone's investment risk profile: Conventional, New Life, Survival, Nothing To Lose, and Financial Samurai.

We will talk through each model to see whether it fits your present financial situation. The proper asset allocation will switch over time of course.

Before we look into each asset allocation model, we must first look at the historical returns for stocks and bonds. The goal of the charts is to give you basis for how to think about returns from both asset classes.

Stocks have outperformed bonds in the long run as you will see. However, stocks are also much more volatile. Armed with historical knowledge, we can then make logical assumptions about the future.

Historical Return For Stocks

To determine the proper asset allocation, take a look at the historical returns for stocks. Stocks generally return around 10% since 1926. Below is a chart that shows the historical returns per year for the S&P 500.

Notes On Stocks

• The 10-year historical average return for the S&P 500 index is roughly 10%. The 60-year average is also about 10%, even after the 38.5% drubbing in 2008. However, there are forecasts for much lower returns going forward mostly due to high valuations.
• The S&P 500 has been volatile over the past 20 years. The golden age was between 1995-1999.  2000-2002 saw three years of double digit declines followed by four years of gains until the economic crisis.
• 2020 was another banner year in the stock market, closing up 18%. 2021 saw the S&P 500 increase by 27%. However, 2022 closed down about 20%.
• The 32% correction and rebound in March 2020 was the fastest in history.
• Your target stock allocation should depend on bond yields

Historical Return For Bonds

The proper asset allocation must take into consideration bond returns. The average return for long-term U.S. government bonds is between 5% – 6%.

Bonds and interest rate performance is inversely correlated. Since July 1, 1981, the 10-year bond yield has essentially been going down thanks to technology, information efficiency, and globalization. As a result, the 10-year bond has performed well during this same time period.

However, 2022 saw the worst year for bonds in history with the aggregate bond market down about 14%. Therefore, know that even bonds aren't always a low-risk investment either. Take a look at the historical bond market returns.

Below is a chart that shows asset class real returns by decade.

Notes On Bonds :

* Bonds have never returned more than 20% in one year. The two times the BarCap US Aggregate index came close was in 1991 and in 1995 when inflation was in the high single digits. Inflation is now around 2% and is expected to go higher with so much fiscal stimulus under the Biden administration.

* As of 2023, the 10-year bond yield is hovering at around 4.9%, up from a record-low of 0.51% in August 2020, and down from a high of 4.25% reached on November 7, 2022. As inflation declines, so will the 10-year bond yield.

* Bond funds have decline dramatically since the Fed started aggressively hiking rates in 2022. Long-duration bond funds like TLT are down over 40%, which shows the risk of owning bond funds versus buying individual bonds and holding them to maturity.

Below is another chart from Vanguard that shows the historical returns of a 100% bond portfolio, 20% / 80% stocks / bonds portfolio, and a 30% stocks / 70% bonds portfolio.

See: Historical Returns Of Different Stock And Bond Weightings

Example Of Bonds Outperforming

Take a look at the performance of the Vanguard Long-Term Bond Index Fund (VBLTX) versus the S&P 500 ETF (SPY) since 1999. VBLTX has thoroughly outperformed SPY by an impressive 62%. This chart is obviously pre-pandemic. But it serves to demonstrate the power of bonds when interest rates are declining.

Now of course, not all bond funds are the same. Although VBLTX is considered a reasonable proxy for bonds, other bond funds may not perform as well.

Here is another chart showing the performance of the VBMFX, another Vanguard bond ETF versus VTSMX, a Vanguard S&P 500 ETF. In this scenario, bonds outperformed the stock market from 2001 to about 2013, or 12 years. Since 2013, stocks have outperformed.

Bonds don’t get as much love as stocks because they are considered boring. It’s hard to get rich quick off a bond. But it is possible to see a quick windfall if you pick the right high-flying stock.

Despite the lack of sexiness in bonds, if you’re serious about achieving financial independence or are already financially independent, bonds are an integral part of your portfolio.

Not only do bonds provide solid returns, bonds also offer defensive characteristics when stocks are selling off. Here's a detailed post on how to buy Treasury bonds . When Treasury bonds are yielding over 5%, I find them to be very attractive given the long-term inflation trend is around 2-3%.

Conventional Asset Allocation Model For Stocks And Bonds

The proper asset allocation of stocks and bonds generally follows the conventional model.

The classic recommendation for asset allocation is to subtract your age from 100 to find out how much you should allocate towards stocks. The basic premise is that we become risk averse as we age given we have less of an ability to generate income.

We also don't want to spend our older years working. We are willing to trade lower returns for higher certainty. The following chart demonstrates the conventional asset allocation by age.

Candidates For The Conventional Asset Allocation:

• Believe in conventional wisdom and don't want to overcomplicate things.
• Expect to live to the median age of 78 for men and 82 for women.
• Are not very interested in the stock market, bond market, or economics and would rather have someone manage your money instead.

New Life Asset Allocation Model For Stocks And Bonds 

The New Life asset allocation recommendation is to subtract your age by 120 to figure out how much of your portfolio should be allocated towards stocks. Studies show we are living longer due to advancements in science and better awareness about how we should eat.

Given stocks have shown to outperform bonds over the long run, we need a greater allocation towards stocks to take care of our longer lives. Our risk tolerance still decreases as we get older, just at a later stage. While in retirement, ideally, returns are conservative , demonstrate low volatility, and generate steady passive income.

Candidates For The New Life Asset Allocation:

• You plan to live longer than the median age of 79 for men and 82 for women.
• Not that interested in actively managing your own money, but depend on your portfolio to live a comfortable retirement.
• Plan to work until the conventional retirement age of 65, plus or minus 5 years.
• Are a health fanatic who works out regularly and eats in a healthy manner. Sugar is synonymous with poison, while raw is synonymous with utopia.

Survival Asset Allocation Model For Stocks And Bonds

The Survival Asset Allocation model is for those who are risk averse. The 50/50 asset allocation increases the chances your overall portfolio will outperform during a stock market collapse because your bonds will be increasing in value as investors flee towards safety.

Bonds can also rise when stocks rise as you've seen in the historical chart above. During the 2008 Global Financial Crisis, a bond index fund only fell by about 1.5%, while stocks declined by 38%. The worst year ever for bonds was in 1994 when bonds fell 2.9%.

Bonds have performed like a champ during the 2020 recession compared to stocks.

Candidates For Survival Asset Allocation:

• Believe the stock market has a higher chance of underperforming bonds, but are not sure given historical data points to the contrary.
• Are within 10 years of full retirement and do not want to risk losing your nest egg.
• Depend on your portfolio to be there for you in retirement due to a lack of alternative income streams.
• Are very wary of the stock market because of all the volatility, scams, and downturns.
• Are an entrepreneur who needs some financial safety just in case your business goes bust.

Nothing-To-Lose Asset Allocation Model Of Stocks And Bonds 

Given stocks have shown to outperform bonds since 1926, the Nothing-To-Lose Asset Allocation model is for those who want to go all-in on stocks. If you have a long enough time horizon, this strategy might suite you well.

Candidates For The Nothing-To-Lose Asset Allocation:

• You are rich and don't count on your stock portfolio to survive now or in retirement.
• Are poor and are willing to risk it all because you don't have much to risk.
• Have tremendous earnings power that will continue to go up for decades.
• Are young or have an investment horizon of at least 20 more years.
• Believe you are smarter than the market and can therefore choose sectors and stocks which will consistently outperform.

Financial Samurai Asset Allocation Model Of Stocks And Bonds 

The Financial Samurai model is a hybrid between the Nothing-To-Lose model and the New Life model. I believe stocks will outperform bonds over the long run, but we'll see continued volatility over our lifetimes. I also believe this is the most proper asset allocation if you consistently read my site.

Specifically, I'm preparing for a new normal of between 7% – 8% returns for stocks (from 8-10% historically). I also expect 2%-4% return on bonds from 4-7% historically. In other words, I believe bonds and stocks are expensive and returns will be structurally lower going forward.

Candidates For The Financial Samurai Asset Allocation:

• Have multiple income streams .
• Are a personal finance enthusiast who gets a kick out of reading finance literature and managing your money.
• Not dependent on your 401k or IRA portfoliso in retirement, but would like it to be there as a nice bonus.
• Enjoys studying macroeconomic policy to understand how it may affect your finances.
• Is an early retiree who won't be contributing as much to their portfolios as before.
• Also invests in real estate to diversify and smooth out the volatility of stocks. Real estate is actually my favorite asset class to build wealth because it is easy to understand, is tangible, provides utility, and has a solid income stream.
• Given a Financial Samurai is a real estate investor, real estate acts as a Bonds Plus type of investment. In other words, real estate is defensive during a downturn as more capital goes towards real assets . Real estate also tends to do well as more investors buy bonds, resulting in lower interest rates. At the same time, real estate tends to do well during strong economic growth due to rising rents and rising real estate prices.

The Right Asset Allocation Depends On Your Risk-Tolerance 

By providing five different asset allocation models, I hope you are able to identify one that fits your needs and risk tolerance. Don't let anybody force you into an uncomfortable situation.

Ideally, your asset allocation should let you sleep well at night and wake up every morning with vigor. When it comes to investing, you need to calculate your existing investment exposure  and invest accordingly.

I encourage everyone to take a proactive approach to their retirement portfolios. Ask yourself the following questions to determine which asset allocation model is right for you.

Questions To Ask To Determine A Better Asset Allocation

• What is my risk tolerance on a scale of 0-10?
• If my portfolio dropped 50% in one year, will I be financially OK?
• How stable is my primary income source?
• How many income streams do I have?
• Do I have an X Factor (ways to make alternative income)?
• What is my Money Strength?
• What is my knowledge about stocks and bonds?
• How long is my investment horizon?
• Where do I get my investment advice and what is the quality of such advice?

Once you've answered these questions, sit down with a loved one to discuss whether there is congruency with your answers and how you are currently investing.

Further, it's important to understand the right order of contributions between your tax-advantaged and taxable investments. You want to take full advantage of your tax-advantaged accounts, while also building up your taxable investments as large as possible. The sooner you want to retire early, the larger your taxable investments should be.

It's important not to overestimate your abilities when it comes to investing. We all lose money eventually, it's just a matter of when and how much. Having a proper asset allocation will improve your odds of building wealth in a risk-appropriate manner over the long term.

Recommendation To Build Wealth

The best ways to build wealth and have the proper asset allocation is to get a handle on your finances by signing up with  Empower . They are a free online platform which aggregates all your financial accounts on their Dashboard so you can see where you can optimize.

Before Empower, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to track my finances. Now, I can just log into Empower to see how my stock accounts are doing, how my net worth is progressing, and where my spending is going.

Their Investment Checkup tool is also great because it graphically shows whether your investment portfolios are property allocated based on your risk profile. The tool allows you to easily determine the proper asset allocation.

Aggregate all your financial accounts in order to get a good over view of your net worth and start building those passive income streams! It only takes a minute to sign up.

Invest In Real Estate To Build Wealth

In addition to investing in stocks and bonds, I'm a big proponent of real estate investing. Real estate is a core asset class that has proven to build long-term wealth for Americans. Real estate is a tangible asset that provides utility and a steady stream of income if you own rental properties.

You can think about real estate as a bonds plus asset class. Real estate acts very much like bonds with its income generating ability and defensive characteristics. However, real estate can often do much better than bonds in a bull market.

My favorite two real estate crowdfunding platforms are:

Fundrise is my favorite private real estate platform. The platform enables all investors to diversify into real estate through private eREITs. Fundrise has been around since 2012 with now over $3.3 billion in assets. For the average investor, investing in a eREIT for real estate exposure and stability is one of the easiest ways to go. I particularly like Fundrise's focus on single-family and multi-family investments in the Sunbelt, where valuations are lower and yields are higher.

CrowdStreet : A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. For investors who like to buy individual properties or build their own select real estate fund, CrowdStreet is my favorite choice.

Both platforms are free to sign up and explore. I've personally invested $954,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. There is a strong demographic shift towards lower cost areas of the country thanks to technology and the pandemic.

Invest In Private Growth Companies

Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment. 

Check out the  Innovation Fund , which invests in the following five sectors:

• Artificial Intelligence & Machine Learning
• Modern Data Infrastructure
• Development Operations (DevOps)
• Financial Technology (FinTech)
• Real Estate & Property Technology (PropTech)

Roughly 35% of the Innovation Fund is invested in  artificial intelligence , which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!

The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.

About the Author :

Sam worked in investing banking for 13 years at GS and CS. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $350,000 a year in passive income . His favorite investment today is in real estate crowdfunding .

He spends most of his time playing tennis and taking care of his family. Financial Samurai was started in 2009 . It is one of the most trusted personal finance sites on the web with over 1.5 million pageviews a month. Pick up a hard copy of my new WSJ bestseller, Buy This, Not That: How To Spend Your Way To Wealth And Freedom . It's the best personal finance book you'll ever read.

About The Author

Financial Samurai

93 thoughts on “the proper asset allocation of stocks and bonds by age”.

In these allocations are “Bonds” something like FUAMX (Fidelity® Intermediate Treasury Bond Index Fund) that only use Treasuries or FXNAX (Fidelity® U.S. Bond Index Fund) that has a mix of corporate and government bonds?

Individual Treasury bonds, municipal bonds, or corporate bonds. You can own a bond fund, however, there is no maturity and you will have to ride its ups and downs.

Is it rational to consider Pension and SS as the fixed components of a portfolio? If yes, how do you !) account for it in asset allocation 2) allocate retirement funds to stocks – 80 to100%?

I stumbled on your Financial Samurai by accident and was impressed by the amount of great information. It’s a very good read.

if you use dividend stocks instead of just using a s&p500 etf or fund for your equity allocation would that allow you to increase your percentage in stocks? Since dividend stocks are more stable and tend to hold up better in a downturn wouldn`t that allow you to go to say 65 or 70 percent equity ? Im 63 years old retired and have a pension and social security so I dont need to dip into my retirement money to much maybe a 4% withdraw rate at 65. Any thoughts or advice on this would be appreciated.I may consider a combination of total stock market etf and dividend stocks for my allocation.

Just wondering – why not you have YT channel? Your posts are great but timely to read.

Retiring. Definitely an opportunity, but it just takes more time and I’m trying to do less, not more. Do you have a YouTube channel?

Can you watch faster than you can read? I can’t.

Awesome job on the breakdown of the bonds! Im definitely more knowledgeable about the mix of bonds and stocks now. Thank you sir.

Long time reader and genuinely attribute my success to following a lot of your advice. I am now “struggling” with a “problem” I would love your take on. Simply put, I am 30 years old, married, and we have a $1.5M net worth ($1M investment account, $500K retirement accounts).

Asset allocation:

US Equity Large Cap: $1M International Equity: $400K Cash: $100K

After Tax Income: $250k Expenses: $90K

Although I am doing well, I am worried about a downturn (although I would just keep buying) and am concerned I’m being a “naive millennial” who thinks markets only go up and am taking too much risk.

However, I really see no reason to buy bonds and make 2%.

Should I just keep buying stocks and see where I am in 3-5 years? I don’t plan on having a family or buying a home until 35.

For one do your wife no anything about it or no whatever the case might be always talk to your wife about anything cuz if anything happened she would be your backbone she will back you up in anything don’t be selfish and trying to take measures on your own hand the things will not never turn out right

How do we invest or mirror the Vanguard VBTLX Bond index? thx.

No one is home here.

Before you can consider retiring…you need a budget. Only then can you really determine things like “risk tolerance”. Figure at least 2-3% inflation and living until 90. Figure your budget today will double by then. Figure your Social Security will be cut by 10% or more in 2035. Figure your spouse is going to die and take their social security with them. Figure your money will run out if you don’t have at least 1 million in savings and IRAs…minimum. Otherwise, figure your 80s will be spent living in a 10′ x 10′ room staring at a wall where a big screen tv use to be.

Interested in your thoughts on asset allocation for my 83 in-laws. Until very recently, they had 100% of their retirement in equities. We finally convinced my mom-in-law to shift to some value-preserving funds… but their total mix is still over 90% (!) equities. My father-in-law wouldn’t consider anything but aggressive growth equities.

They have modest teacher retirement payments, and Social Security, but are otherwise depending on their IRA savings for continued retirement and ongoing medical care. They’ve been saving using the stock market since the late 70’s in both IRAs and 403(b) plans at various times.

They survived the plunge in 2008 with great angst, and the good fortune of living much longer than average. Unfortunately, my father-in-law has recently gone into memory care for dementia and my mother-in-law has just had a mild heart attack. Even though they seem to have the “Nothing-to-lose” model in mind, they definitely DO have much to lose.

Their children (all are CPAs and two are CFOs for decent sized corporations) are trying to convince my mom-in-law that a mix of no more than 60% equity funds and 40% bond funds or other capital preserving assets would still satisfy their aggressive earning desires but at least keep them away from losses that they don’t have long enough to to live and recover from a big loss. Personally, if I were 83, with nearly 1M in assets, I would have all my assets in something that I would preserve value for my living AND to transfer to the grandkids when I was gone. Not for them, though.

Any suggestions on how we can present a (to me at least) more sane asset allocation for very senior adults?

The asset allocation is all good as bonds are negatively correlated with stocks in general. The correlation could change as the market condition changes. The bonds will reduce the beta weighted delta of your stocks. One could even reduce the volatility or so called standard deviation of the P/L of the stocks/bonds portfolio by adding some negative delta via options to reduce the cost base of your assets. Why not more retirees or would-be retirees are doing that? Wall street’s self-serving and widely perpetuated myths that options are risky is probably the answer.

Hi there, I am 48, working full time and used to be 100% in stocks/mutual funds. Start investing since 2003, managed 2008 and hold on during the storm, but now at my age, my obligations (has a daughter at univeriaty & son to prepare within 8 years time), I am chicken out with current market turmoil. Intend to restructure my investing strategy next year. I live in Indonesia where interest rate at 6%, 10 yrs government bonds at 8% and average 20 yrs stock market index at 20%. Seeking your advice. Thank you

Haha, very true!

This whole conversation started out as you can see, where I have a good friend and daytrader who is trying to time the market downturn using all these principles like Elliot Wave, etc.

Sure, people have made money timing the market but a lot also haven’t! Basically, this is what led to me to the question of whether I should change my allocation (from 100/0 to maybe 80/20) based on my retirement year, etc. and also whether I am still gambling in doing so based on the recent downturns in the market these past few months… It is very hard to predict the market, even if you’re REALLY REALLY GOOD AT IT.

I prefer to keep my money in mostly stock since I have had a good amount of exposure therapy to volatility and the ups and downs. I only rebalance once a year and this is when I typically look at the market :)

Cool. So what are the answers to my questions for you?

The answers to your questions :) Sorry for the delayed reply!

1. Working 2. 28 years 3. 2 different streams of revenue, in addition to my market investments of course. 4. Single and no family as of now; if I do decide to have a family it will be around 40-45!

Hello Financial Samurai!

GCC mentions in his path to 100% equities article that in all honesty, as an early retiree ages, almost independent of the market, it is best to have 90/10 or 100/0 stocks as this will help one’s portfolio grow the most (as long as they can withstand the volatility, which is not too hard if you only look at it once a year :) ).

What are your thoughts on this compared to the 80/20 or 70/30 split that you recommend in your portfolio allocation model? When you get up there in age, I can see the portfolio being shifted slightly more to bonds due to healthcare costs and also because you have less years to live… but other than that, I see no reason why 90/10 split shouldn’t be a thing!

Curious as to your thoughts, thanks so much.

Hi Sean, I wish GCC and others 100% in equities the best of luck. If they have the risk tolerance to stomach the volatility, go for it. This recent 10% correction in October 2018 is a nice test.

I’ve found that the more you accumulate and the more you don’t want to ever go back to work, the less risk tolerant you will be.

For me, it would be a disaster if I or my wife had to go back to work with our 18 month old boy now. We are committed to being full-time parents until he goes to kindergarten (age 5.5-6) at least.

See: Investment Risk And Return Portfolios For Early Retirees to see the returns

Also, here’s our story on how a jobless family of three survives in San Francisco .

We really don’t want to return to work. Nor do we want to be forced to live overseas to save money. We want as many options as possible!

I totally understand where you’re coming from; typically, for me to avoid volatility I just don’t look at my portfolio :)

But I understand that a 50% crash like in 2008 can sometimes cause people to sell unnecessarily (even though I believe this was a “rare” recession with a crash this large, and from what I know, the market hadn’t dropped this low for that long since Depression era times…).

Regardless of whether 2008 was an outlier or not, it’s true though that even though you accumulate more responsibility, you also accumulate more in terms of wealth? For example, even if you lose 50% of your wealth during a recession, eventually the market comes back up, and an early retiree should still have more than enough in a brokerage account and also in dividends to last him during that period in time without worry? Since you have more years to ride out the volatility too, this is a much different portfolio allocation than someone retiring at 65 of course who has less years and maybe would be content with a 70/30 split.

The more years you ride out your retirement funds, the more they will grow with only nominal market performance. Investing in more stocks (90/10) will be more volatile, but will also increase your returns exponentially compared to a 70/30 split, so it should lessen your worries even more about money!

Again, I ran all of this data in the FireCalc Sim (and accounted for taxes), so this is where I am coming up with the numbers :) For me, I can hedge against the volatility although I can understand not doing so with a family as it will be tougher. I can understand too that if someone early retired at the beginning of a sustained bear market and not a bull, they will need to spend less and save more to ensure that they don’t outlive their funds.

Some pertinent questions to ask you are:

* retired or working * age * abilities to make money elsewhere * number of kids/people to support

I’ve found that everybody 35 and under tend to think they are warren buffet!

I’m 34 and can confirm.

This article is one I will be sharing with my wife. While she is a great saver, she is not patient to have these allocation conversations. I was planning on having another one of these conversations with her soon, and this page saved me a ton of work. Thank you for posting it.

Love your blog, super insightful and very helpful. A little about me, just moved back to my Seattle rental from the Bay Area – relevant to your last few blog posts. Anyway, I have a fairly simple retirement strategy, healthy mix of index funds. I was curious from your perspective – the right allocation between US and International. I like your 80% Stocks and 20% Bonds mix above, but I am curious … how would you break up:

Larg Cap Mid Cap Small Cap

International

J.L. Collins would recommend investing 80% in VTSAX (Vanguard Total Stock Market Index Fund) & 20% in VBTLX (Vanguard Total Bond Market Index Fund). Happy investing!!!

Or VT and BIL in the particular percentages based on your own risk profile and age.

Very good article and comments, thank you. Readying to retire in 1-2 years, I have become very fond of Wade Pfau’s theories and alternatives. That is …. in its most distilled form, 1-2 years before retirement, decrease your stock allocation to approx. 30% . Thereafter, increase by 1% per year. He suggests this so as to not be so stock heav close to retirement in case we run into a down market, thus leaving an investor with limited ability to catch up. Thanks again, Frank

Hey Sam Heard you on my buddy Noah Kagan’s show and decided to come check out your blog. So far, I love it. The only thing I wanted to suggest was that many of us reading have other investments outside of stocks/bonds. I would’ve loved if this post had addressed how much each of these frameworks carry in assets like Real Estate, cryptocurrencies, fiat currencies, etc. In any case, my assistant will be dropping you an email to invite you to come onto our show, Becoming SuperHuman, so hopefully we’ll get a chance to talk more

Hi Jonathan, nice to meet you. I actually go the deepest in real estate on my side, and also talk about private equity and venture debt.

My real estate category for you to check out : https://www.financialsamurai.com/category/real-estate/

Hi Sam – Where do you see cash fitting into the allocation strategy? I’m a fairly active investor turning 50 this year and unable to continue to contribute to my IRA, but with all of my accounts considered, I should be OK in retirement. Currently I’m 50% stock, 25% cash, 25% bonds. I’d go down to 10% cash and up to 65% stock if the market takes a dive. Thoughts?

Also, something that’s always confused me about the bond ratio is whether it matters what type of bond it is. I have several different types of bond funds in the interest of diversification. Munis in taxable accounts, corporate debt, mortgage/asset backed securities, and treasuries in my IRAs. It seems like whenever anyone is talking about the bond ratio they are assuming a full allocation into treasuries. Can you comment on that for me please? Thanks!

See Recommended Net Worth Allocation . I like having around 5% of my net worth in cash or CDs.

You should also read: The Case For Bonds: Living For Free And Other Benefits

AFter the Trump victory, I built up a sizaable municipal bond position.

Thank you! :)

Hi Sam – Thank you for taking the time to create such a comprehensive and thoughtful website. It’s been inspiring and motivating, and I’ve been rethinking my portfolio.

What allocation would you recommend for a 40 year old that does not own real estate? I live in NYC and renting is a better option for me than buying, especially with pricing right now. I’m currently Cash 55%, Equities 43%, and Bonds 2%.

I want to stay liquid just in case there may be buying opportunities in the coming years. With that said, I think that a greater exposure to bonds would make sense. But I don’t know how I feel about a such significant increase in bonds given the market today. And I’m unsure about putting more money in an equity index since the broader market has been performing well over the past years.

What you suggest for someone who most likely won’t be able to invest in real estate for at least another three to five years?

Thanks in advance, C

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I’m considering doing a full-time MBA in the fall of 2016. Do I have enough time to put money in stocks/bonds, or should I shoot for a high-yield savings account? I am 27, make $80k a year, and have a wife+1.5 kids. I’ve got $20k in retirement and another $10K in cash.

On a side note, you should do a post about the costs of an MBA. I’d love your perspective.

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I have a hard time with bonds right now as the interest rates are being kept artificially low and are due for a hike. Even the Fed has announced that they are going to hike rates ‘sometime soon’ and it seems like buying bonds now is betting on a sure loss.

Im not saying that one can ever time the market (if you can, by all means let me know), but to me this seems like a common sense observation that interest rates really can’t go anywhere but up.

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This was super helpful Sam. I just found your blog via this post. The “new life” model more or less describes me exactly. I left my salaried law firm job so I no longer qualify for a 401(k). I set up a traditional IRA with my robo-advisor of choice and put my first $5,500 in.

Now I just need to figure out what to do with my extra cash savings: renovating to further increase the value of our Brooklyn apartment (which has gained about 20% in value since we bought it), making additional securities investments, contributing to my 2-year old’s 529 savings plan, etc.

Good stuff. What do you plan to do post law?

I joined an educational game design boutique and am apprenticing and learning skills as a producer of interactive learning experiences. Those may take many different forms, though web-based games for middle and high-school students are my current project.

Hey guys. New investor here and looking for some direction. I have a basic understanding of how things work and am trying to figure how to best allocate funds for a 401k.

It’s managed through Wells Fargo. I looked through at 10 year returns as well returns since inception and there are not that many success stories among them. I’m 26 and plan to have a good pension to retire on after many years in the school system so I’m look to gamble a little bit and give this thing a try.

The one’s I’m leaning towards are:

Goldman Sachs Sm Cap Val/A- 50% Janus Global Research Fund Class A- 10% T. Rowe Price Equity Income Fund- 20% Amer.Cen. One Choice Tg Date Port 2045 I- 20%

Does this look a decent set up? Thanks for the help!!

Hey, I’m 37 have 380K saved but missed the full bull of market. Since 1999, lost 200K in principal in stocks. I only re-invested back 50% of my money in 2012. I gave 50% in cash. Market is now at 17,000 DJIA from 6,500 in 2008. Do you think I should buy 30% more stock now? or don’t you think its so overpriced? also, I just want to buy VANGAURD ETF and lower my fees. Do I get dividends back when I buy ETFs? How do i invest to get dividends- do I must buy individual stocks. I really don’t trust money managers, they are just salesman. your thoughts/

You’ll get a dividend from the dividend ETF as well just like a stock.

It’s hard for me to advise you without understanding your full financial picture.

Check out this post for a free financial consultation: https://www.financialsamurai.com/get-a-free-financial-consultation-with-personal-capital/

I am conflicted here. I made to 74 and the old age doc says I am healthy and may last 15 years or more ( my mom’s age). So do I accumulate more equity or less? Part of you says 50/50 equity to bonds, but that is at 65 years, Then another option is to increase equity later on. But if is pretty certain that I will not run out of money should I invest as though the grandchildren will be the ones to fritter it away and maximize gain as though I am young again? Maybe I should use the Markowitz way of investing to make one feel the least bad when things happen.

Hey Samurai–nice blog.

One comment on asset allocation models: According to theory, (right I know), the ideal portfolio for “everyone” is the tangency portfolio. With a typical mix of S&P 500/5 year treasuries (and I know it doesn’t have to be just these), if you look at diagrams, the tangency portfolio generally seems to be about 50/50, maybe closer to 45/50. This gives you the highest Sharpe Ratio (unit of return/unit of risk). Then what you are supposed to do if you want a higher return/higher risk is leverage at the risk free rate, if you want less risk you add the appropriate amount of cash reserves to your portfolio (and get less return), but this maintains the efficiency of the portfolio by keeping the Sharpe Ratio as high as possible. This isn’t really a point I see raised very often in AA discussions but it is relevant since the whole underlying theory of caring about an AA of the portfolio in the first place comes from MPT & CAPM.

Look at that S&P historical chart.. Today really does look like 60’s and 70’s

I wonder if we are in “1973” setting up for another 1975 pull back? https://stockcharts.com/freecharts/historical/djia19601980.html

chartists believe that long term bull markets come after a prolonged range bound period (10-20 years) and we must retest the low of the range once more before a 1980’s/90’s bull. Secretly I hope so I need to reason to sell bonds and go overweight stocks…

I hope not, but the stock market sure feels frothy right now.

Long term, everything is up and to the right.

I am new to the investment game….I am about to become eligible for my company’s 401k in which they match 50 cents to the dollar up to 8% of my contribution. My salary is only $33,500 but I have my annual review tomorrow so hopefully a raise will be coming. I am curious what your advice is as far as how aggressive I should be with where I put my money in my 401k. My company has about 12-15 funds where I can put my money ranging from low to high risk. We also have the option of just putting it into a moderate, growth or aggressive balanced portfolio where the investment company we use picks stocks/bonds for you.

I also have some money in my savings account that I am considering putting into a separate IRA as it is just sitting there accruing next to nothing. I have about $10k saved but I wouldn’t want to put it all in the IRA…suggestion on how much? Or if I should even invest this money?

If it helps…I am 35 yrs old.

I am a new hire at a large company with a great salary and am starting to contribute to my 401k from day 1. Ofcourse I will be maxing it out, receiving all employer contributions, etc., etc., but I am having trouble deciding where to allocate my 401k funds. I want to start off with high-risk high reward funds, seeing as I potentially have 30 to 40 years to invest. My current plan is to start out with almost 100% stocks. I’ve got 40% in a 30 year retirement fund (high risk), 40% in a low-fee S&P 500 index fund, 10% in emerging markets, and 10% in international stock (Europe & Pacific). I am very new to investing, but have been following your blog for some time. I’ve seen the bull market and it’s earnings the last few years and am wondering if I am now at a peak as I start investing. I am withholding my post tax income for the next 6mo to a year in a money market as I save up for a down payment on a condo (in a large city on the west coast). Being new to investing and not formally educated in finance and economics, I am having a hard time predicting any markets or even understanding trends of current markets (I’m still doing much research). What is your opinion on 401k allocation for a new hire? Also, as a side note, how would you consider the housing market over here on the west coast in the large cities? Prices have risen quite a bit since the real estate collapse and I missed buying during this time (still studying in college), but am wondering if it is still beneficial to jump in the housing market before it gets even pricier. My best guess would be to go for it because I doubt the banks would make the same mistake twice so soon, which would allow for real estate markets to steadily rise again. But like I said, I am no expert by any means.

Just ran into this site a couple of days ago after getting serious about my future and my family’s future. I’m totally hooked to the site, reading articles after articles trying to grasp everything I’m reading. I’m 24 years old, engaged and have a 1 year old son. Unfortunately I’m not doing to good on the savings side and am on my way towards creating a savings plan now. I’m curious to know how I can start to scratch the surface of investing in Stocks and Bonds. Maybe you already have an article on this? (for example if you recommend trying to start off with etrade or things of that nature) Or should I not even consider this until I have some money saved up?

just for added details I make $40k a year (and drowning in student loans lol.. over $47k)

My apologies in advance for bombarding you with questions lol.

Thanks for taking the time out to read this! Any advise is appreciated.

Welcome to my site! Feel free to subscribe.

With the info you have provided, I would simply focus on contributing to your 401k/IRA and maxing those out first before spending more time in after tax investing. I’d also focus on paying down that debt.

Thanks for reminding us about the asset allocation and its importance in relation to risk tolerance. I’m in my mid-30’s and have chosen 75% stocks, 25% bonds/cash equivalents. I probably need to increase my allocation in stocks. Thanks for the reminder.

As I sit here in retirement today, I can unequivocally say that rental income is fantastic. My rental income is supporting my lifestyle as I just bank/reinvest any stock returns and dividends. Rental income just takes time.

We allocate our assets, our stocks, bonds, and cash, because we want to get the return that we are aiming for while minimizing the risk that we are exposed to. You need to decide how to divide your assets and choose an investment that will go with how you divide your money.

I ‘m definitely with the “nothing to lose” model. The return on government bonds currently are so low that you are actually losing money investing there. Certain corporate bonds do better, but again, its pretty limited. I’m also hopeful that my dividend stream in solid, reliable companies will grow large enough to cover my expenses such that I won’t need bonds into my retirement. You also have an automatic inflation hedge built in with dividends that you dont get with bonds (unless they happen to be TIPS- treasury inflation protected). Moving some of your income to bonds when you hit 65 does make some sense though, the time to take risk has probably passed you by at that point.

Indeed. At 65, or thereabouts… hopefully we’ve all developed a big enough nut where it’s all about living off the passive income generation rather than relying on capital increases.

I think you are doing great! With your time horizon, skills as a developer, and your initiative to work on multiple income streams, you should be fine. The FS model seems appropriate, but only you can decide.

The one thing to note is that things change all the time. You may think you can work for the next 20 years no problem, but I think you’ll be surprised if you work on your X Factor. You never know. But you’ll definitely never know if you don’t try. My article on Yakezie.com is something I’ve been thinking of trying. Worth a shot? Maybe! Gathering feedback now and need a developer.

The “Nothing To Lose Model” is 100% stocks until age 65 or whenever you no longer want to work, or have all your expenses covered by passive income.

The one key thing I want everybody to know is that we will all lose money eventually. Nobody can consistently beat the market, no matter how smart we think we are. Everything is easier said than done.

Ive always felt avoiding the latest meltdown in stocks is really the best investment strategy. Bear markets typically last .5-2 years and then you get a bull maket for several years until your next bear market and the cycle repeats itself. So simplistically the closer you are to the last bear market time-wise the more bullish you should be on stocks. I’m bullish on stocks in 2013 but am not as bullish as 2012. I’m slowly decreasing the percentage I have invested in stocks every year from now until the next bear market where I’ll try to buy back in and repeat the cycle.

If you can tell us when the next bear market will start (within the month is fine), shoot me an e-mail and give me a heads up would ya? I’ll even buy you a steak dinner as a reward.

Haha well I cant tell you when its going to start but the idea is the farther you get from 2009 the more cautious you have to be when the market enters a downtrend (just follow moving averages for simplicity). By now were far enough removed that I wouldnt be 100% in stocks but not far enough removed where I’m overly worried about a crash. There will be another crash someday in the future though and even if you only manged to save half your portfolio from the effects of it thats a huge deal especially if you can buy back in a year later anywhere close to the bottom.

I consider more than risk tolerance with my asset allocation. In retirement (this time) I will have all my basics covered by Social Security and a pension. That represents the fixed portion of my retirement. My stock market portfolio asset allocation is intended to shield me against a very volatile market and still be a growth portfolio. I expect to live 30 years in retirement and want sufficient funds to support my wants in life. In the next five years, I do expect to shift more funds into TIPS and dividend paying stocks (funds). I think I will stop at 20-25% though. This plan could change, but that is what it is today.

I have a pretty high risk tolerance, and right now my asset allocation most closely resembles the ‘new life’ model although my mix will probably trend more aggressive compared to the chart at older ages.

From conversations I’ve had I think this past recession really put some permanent doubt in peoples minds & a lot of people will be trending to a more conservative going forward than they might have in the past.

No doubt the massacre of 2009/2010 is going to scar the existing generation of investors for a very long time, myself included.

My #1 tenet in investing is not to lose money! If I can’t make money, fine. I just refuse to lose.

Is there a post about your portfolio around 2008, and how you were able to not loose money? I’d be very interested in that

Thanks, A.D

I don’t think so. I lost around 35% of my net worth in 2008-2009, hence why I started Financial Samurai in July 2009 to get my finances in order.

But most of my net worth was in real estate and cash. Not so much equities, b/c I worked in equities.

Gotcha – I’ve been binging on your blog since December. Next objective is to get the fiancé on board, and have the cheapest (big fat indian) wedding possible.

Thanks a tonne and looking forward to the dialogue!

Well, that’s a very interesting statement you just made: “But most of my net worth was in real estate and cash. Not so much equities, b/c I worked in equities.” Yet the whole article is about investment allocations (by risk level and age) in equities and bonds. Hummmm… So, having worked in equities you obviously have some serious issues with them — would love it if you would share your concerns.

Sure. My career was in equities and I already had hundreds of thousands of dollars in company stock and in my 401(k) plans. I needed to diversify away from stocks given my career, bonus, and already a lot of my net worth was already invested in stocks.

Now at 41, I’ve got about 25% of my net worth in stocks, 35% in real estate, 10% in low-risk investments now that interest rates are up, and the rest in my online business.

See: Financial SEER

I like the Financial Samurai asset allocation plan. However, once I hit 65, I probably would increase my bond allocation quite a bit. When you get older, your risk tolerance usually reduce quite a bit. My bond allocation went down a lot after I rolled over my 401k. I really need bump up my bond allocation, but the rate is so low right now.

I’d consider a stable value fund instead of a bond fund. It’s essentially a cash alternative with better yields.

Agree 100%. And that is what I am doing in my 401K currently

I have a pretty low risk tolerance. I just hate losing money which is also why I don’t gamble. I loved all the analysis and data points that you included in this post. Volatility in stocks is nuts. I’m glad I’m not a portfolio manager or I’d be a major stress case. I have a fairly large fixed income allocation and don’t have any current plans to change it. I am thinking about getting more structured notes though as my CDs expire since your recent post got wheels turning.

First of all, I don’t think there are any wrong answers here because nobody knows what the future will hold. My opinion thought is once you’ve made your nut, why would you risk so much of it. I understand you have to outpace inflation and keep skin in the game, but I think there is nothing wrong with hitting singles and being the tortoise that finishes the race with the least risk possible with an acceptable rate of return. Is your allocation a percentage of total net worth, and do you consider the equity of business ventures and real estate in this percentage?

I agree. The proper asset allocation is based on your own risk tolerance.

My asset allocation charts are for investment portfolios in stocks and bonds only. I’ll do a follow up on net worth allocation. That is going to get a little more complicated since there are so many other types of investments.

I would be very interested to read your thoughts on total net worth allocation.

Personally, and this may change as I age, but I am hesitant to put too much trust into low yielding bonds, unless I don’t have access to real estate that is. Personally my allocation looks a bit like this:

* 50% invested into direct real estate purchases, very close to home for constant monitoring and control, or better yet a duplex(with a fire suppression system and decent insurance). Passive income streams from good tenants, if you can find them that is. * 50% into my investment account allocations(Warren Buffet Portfolio): * 10 % of the investment account allocation into bonds and bond funds, this gives me some ability to re-balance the portfolio to buy assets that are crashing and falling in value at a good price. * 90% of my investment account allocations into US total stock market, and perhaps some global stock market funds

This plan depends upon the solidity of real estate as a backbone for passive income and later retirement, and the bonds to provide funds for rebalancing. Bonds are in a bear market and getting eaten by inflation but stocks have been in a bull market for quite a while. It stands to reason that at some point this will change.

Allocations are strategic and diversified. It is nearly impossible to beat the Warren Buffett portfolio for stocks and other market investments……..but they are not as solid as physical rental real estate. A tangible asset in an isolated market can provide massive levels of insulation from market fluctuations.

My on paper plan looks very risky, because all my brokers can see is a plan to hold 90/10 in stocks and bonds for very long periods of time and possibly pass it on as a trust…….not adjusting based on age looks suicidal, however that ignores my real portfolio which is heavily invested in real estate.

Interesting, why do you think bonds will have a negative return over the long run? Wouldnt debt still retain value as someone will always want to lend money? Further, I think that sitting on the other side of this debt bubble, lending standards have increased and may stay strict for quite some time.

Personally I’m not in bonds much as I subscribe more towards the riskier end of the spectrum. I’m 28 and my investment style probably falls somewhere in between the “Financial Samurai” model and the “New Life” model.

Because of an asset shift away from bonds into riskier assets like stocks. If you look at the 10-year bond movement in recent levels, anybody who bought a month ago is losing money. The charts will give you some idea.

But that’s only if you sell it though, no? I’m a buy and hold guy so I guess I never consider the alternative much. I don’t think I will ever get out at the peak or buy at the bottom so I don’t try, I would rather make decisions on good fundamentals and have enough buffer to ride out the storms.

Sure. If you never sell anything, you will never lose anything. All is good!

I bought 300 shares of 3M, 250 shares of Berkshire Hathaway and American growth fund-mutual fund in 1980 and left it without even looking at the stocks as I was engrossed in my scientific and teaching. In 2010 prior to retirement I took a look. It had ballooned to 750,000.

My cousin who bought only google and Amzon in 2000 has retired with the two stocks not bothering to buy bond and going crazy.

The key is when you stocks you are buying company. Know the company well . Merck, Honewell, Boeing, Lind (Praxair), Medtronics are very good stocks to buy and leave it alone.

I never thought of a “neutral” rating as a lack of conviction, statistically, most stocks are going to perform around average, so “neutral” is just a way of saying, “This stock is likely to neither out- nor underperform. But because my employer has a vested interest in us maintaining coverage on this company, I will publish this report that shoes nothing earth shattering.”

It’s a great job if you can get it. Pays easily $200,000-$500,000 a year. You can be the King Of Neutral ratings e.g. Coming out with a Strong Neutral call today!

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• Monetary Policy
• Fixed Income

Allocating to real and alternative assets: a framework for institutional investors

• Insights Paper

Institutional investors have significantly increased their allocation to real and alternative assets, such as private equity, real estate, infrastructure and private debt, over the past decade, with the objective of enhancing the return or the expected yield of their portfolio, as well as improving its diversification. Integrating such assets into these portfolios raises a number of challenges linked to their limited liquidity, their strong specificity and their sensitivity to risks that are not integrated in traditional financial frameworks. As a result, standard portfolio optimisation is ill-adapted to portfolios mixing standard and alternative assets.

To face these challenges, we think it is important to embrace an approach that combines quantitative and more judgemental elements to portfolio construction, as this may help investors answer questions about how to define their allocation to these assets. A one-size-fits all solution does not exist, hence dedicated advisory work is the basis to understand how to best integrate real and alternative assets in each investor allocation.

The first section of this paper is designed to describe the specificities of these assets and the difficulties in analysing and modelling them due, in particular, to their high degree of idiosyncraticity and to the lack of widely-accepted representative benchmarks, leading to the frequent use of proxies to represent them. We also underline that they are subject to a survivorship bias that needs to be taken care of, while back-filling sometimes has to be conducted to cope with missing data. Another feature is that their performance is often represented by IRR (Internal Rate of Return) rather than by time-weighted total return, and we explain the differences between these two measures.

The second section is focused on the quantitative component of our strategic asset allocation framework for portfolios including real and alternative assets, which is built on three main pillars:

• an integrated approach for modelling standard and alternative assets based on macro and financial factors;
• a specific modelling of liquidity, as a key feature distinguishing these assets from their traditional counterparts;
• a flexible approach to portfolio optimisation and construction emphasising expected shortfall as a recommended risk indicator for portfolios that include these assets.

The models we have developed to estimate returns of private equity, real estate, infrastructure and private debt (described in more detail in our Annual Expected Returns document) can be qualified as normative as they typically propose a decomposition of return between macroeconomic variables, such as GDP growth and inflation in the case of real estate, to which we add a risk premium. These, as well as a liquidity model able to cope with left-tail events (to which these assets can be particularly sensitive), have been integrated in our CASM (Cascade Asset Simulation Model) platform to ensure consistency of approach when designing the allocation of a multi-asset portfolio. Meanwhile, they do not take into account the potential value added of alternative asset specialists in selecting and managing these assets, nor the very strong dispersion of returns between different alternative assets, but they are needed when setting the strategic asset allocation (SAA) of a cross-asset portfolio. We also show that the optimisation process for portfolios that include these assets should focus on expected shortfall as a risk indicator, leading to more diversified allocations than when applying traditional mean-variance optimisation.

The third section includes qualitative elements that should be integrated in the allocation process, along with the formulation of a number of practical recommendations that investors should follow when envisaging allocation to these assets.

Our conviction is that a decision to allocate to real and alternative assets cannot be based on a pure quantitative framework. The approach we recommend and which is described in this section can be qualified as pragmatic. Allocation to these assets, in particular, should be adapted to the investor’s objectives, investment horizon and risk appetite, as well as a clear understanding of the risk of these assets. An example of investor specifics that we address, and that illustrates the need to go beyond pure portfolio optimisation, is that of very large investors, whose allocation to alternatives might be constrained by capacity issues as the marginal return expected from additional investment opportunities tends to decrease above a certain absolute size.

We also highlight that one of the key benefits of real and alternative assets is their diversification potential and that such diversification needs to be looked at from different angles:

• diversification against traditional asset classes due to their characteristics in terms of liquidity and types of companies they provide access to;
• diversification between different types of real and alternative strategies, in particular in terms of investment horizons, that allows investors to combine private equity, private debt, real estate and infrastructure in their portfolio in order to efficiently manage their expected liquidity needs;
• diversification within each alternative asset class, due to the diversity of strategies that they cover: for instance, private equity categories include venture capital, mezzanine, leverage buy-outs (LBO), sector funds among others.

Real and alternative assets can be integrated in a dynamic allocation framework, such as our Advanced Investment Phazer model, in order to determine whether the investment environment for the years ahead might be more favourable to high-risk strategies such as private equity or to lower-risk ones such as private debt. While recalling that SAA remains the key decision and it is highly recommended to invest in these assets in a regular way over several years, these more dynamic decisions can help investors to potentially accelerate or decelerate the pace of their investments into these assets.

The pragmatism we recommend is also illustrated by our conviction that implementation issues are particularly important when dealing with these assets, as they require highly specialised skills in terms of analysis, legal expertise or ability to manage them. Risk analysis and monitoring should also be subject to particular emphasis, as real and alternative assets carry additional types of risk (such as legal, industrial, project risks) compared with traditional assets. Different types of investment vehicles, whether funds, co-investments or direct holdings, are available and can help address different investor needs or degrees of familiarity with these assets.

In conclusion, we believe that institutional investors’ increased interest in real and alternative assets is fully justified by the different benefits that they bring to asset allocation, particularly in terms of portfolio diversification, but success in this area depends on a number of conditions. Among them are a solid framework to model the behaviour of these assets, as well as pragmatism in applying it. The ability to rely on sizeable and specialised skills to conduct in-depth analysis of the risks of these assets, along with utmost rigor in investment implementation, are also key elements of longterm performance in this field.

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Negotiating Equity Splits at UpDown

By: Noam Wasserman, Deepak Malhotra

Michael Reich is having severe doubts about how he split the equity with his co-founders two months ago, when they completed a one-page "November Agreement." Since then, Michael has found an angel…

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Michael Reich is having severe doubts about how he split the equity with his co-founders two months ago, when they completed a one-page "November Agreement." Since then, Michael has found an angel investor and has worked non-stop on the business, while one co-founder was off enjoying the winter break with his family and the other worked on lucrative consulting contracts for other companies. Michael has just sent his co-founders a proposal that would re-allocate the equity within their founding team, and all three founders are getting ready to reopen a negotiation they thought had been finalized.

Learning Objectives

To give students first-hand experience negotiating with team members, in the context of a founding team splitting the equity within a new venture. Also, to provide insight into the issues involved when renegotiating in the shadow of a previously agreed up arrangement. This case is the core case in a series that is useful for negotiation exercises. The three supplemental cases that complete this are (1) UpDown: Confidential Instructions for MICHAEL, 809-021, (2) UpDown: Confidential Instructions for GEORG, 809-022, and (3) UpDown: Confidential Instructions for PHUC, 809-023.

Jul 18, 2008 (Revised: Nov 19, 2012)

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Return on equity approach reveals profitable prospects.

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In this article I cover a strategy that identifies stocks with strong return on equity (ROE) and give you a list of stocks that currently pass the AAII Return on Equity screen . Return on equity may help to reveal profitable firms, but does Wall Street reward the stock prices of these firms? The AAII Return on Equity screen has gained 10.7% annually since inception in 1998, while the S&P 500 index has returned 5.6% annually over the same period.

Measuring Profitability By What Shareholders Earned

Return on equity is a popular measure of profitability and corporate management excellence. The measure is determined by dividing the firm’s annual earnings by shareholder’s equity. This relates earnings generated by a company to the investment that shareholders have made and retained within the firm. Shareholder’s equity is equal to total assets of the firm less all its debt and liabilities. Also known as stockholder’s equity, owner’s equity or simply equity, it represents investors’ ownership interest in the company. It is also known as the book value of the company.

Warren Buffett considers it a positive sign when a company is able to earn above-average returns on equity. Buffett believes that a successful stock investment is first and foremost the result of the underlying business; its value to the owner comes primarily from its ability to generate earnings at an increasing rate each year. Buffett examines management’s use of owner’s equity, looking for management that has proven its ability to employ equity in new moneymaking ventures, or for stock buybacks when they offer a greater return. If the earnings are properly reinvested in the company, earnings should rise over time and stock price valuation will also rise to reflect the increasing value of the business.

Return on equity indicates how much the shareholders earned for their investment in the company. Annual net income of $100 million created on a base of $300 million in shareholder’s equity is very good ($100 ÷ $300 = 0.33, or 33%). However, $100 million in annual net income relative to $3 billion in shareholder’s equity would be considered relatively poor ($100 ÷ $3,000 = 0.03, or 3%). Generally, the higher the return on equity, the better. A return on equity above 15% is good, and figures above 20% are considered exceptional. However, it is important to compare return on equity with industrywide averages to get a true feel for the significance of a company’s ratio.

Return On Equity Defined

Return on equity can be simply stated as net income divided by common shareholder’s equity. However, return on equity can be broken down into three components: net profit margin, asset turnover and financial leverage. Multiplying these three components together results in return on equity.

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The net profit margin—net income divided by sales—reflects how efficient a firm is in operations, administration, financing and tax management per sales dollar. A rising or improving profit margin over time translates into an increase in earnings for a given level of sales.

Asset turnover—sales divided by total assets—shows how well a company utilizes its asset base to produce sales. Poorly deployed or redundant assets result in low asset turnover that adversely reflects return on equity and profitability.

Multiplying profit margin and asset turnover together results in return on assets (ROA). A firm can increase its return on assets, and thereby its return on equity, by increasing its profit margin or its operating efficiency as measured by its asset turnover. Margins are improved by lowering expenses relative to sales. Asset turnover can be improved by selling more goods with a given level of assets. This is the reason why companies try to divest assets (operations) that do not generate a high degree of sales relative to their value, or assets with decreased sales generation. When examining profit margins or asset turnover, it is important to consider industry trends and compare them to how a company is doing within its industry.

Financial leverage completes the return on equity equation. Financial leverage—total assets divided by common shareholder’s equity—indicates the degree to which the firm has been financed through debt as opposed to equity sources. The greater the value of this leverage ratio, the greater the financial risk of the firm—but also the greater the return on equity. When equity is small relative to debt, generated earnings will result in a high return on equity, if the firm is profitable. The risk with high levels of debt is that a company will not generate enough cash flow to cover the interest payments during challenging times.

Debt magnifies the impact of earnings on returns during both good and bad years. When large differences between return on assets and return on equity exist, an investor should closely examine the liquidity and financial risk ratios.

The ideal firm would maintain a high net profit margin, utilize assets efficiently and do it all with low risk, as reflected by a low financial leverage. The key in working with return on equity is examining and understanding the interplay between the determinants of the ratio.

Implementing The AAII Return On Equity Screen

The primary goal of the AAII Return on Equity screen is to identify companies with consistently high return on equity. Secondarily, the approach includes characteristics to filter out firms with high levels of debt, low margins and low asset turnover relative to industry medians.

The AAII Return on Equity approach starts by seeking out companies operating with a return on equity 1.5 times their respective industry median over the last 12 months and each of the last five fiscal years. This screen helps to reveal companies whose management has consistently generated the highest profits from its equity capital. The AAII Return on Equity strategy does not simply screen for companies with return on equity levels of 20% or higher but instead looks for ratios that are high relative to industry norms to highlight firms outperforming their peers.

Stocks Passing the Return on Equity Screen (Ranked by Return on Equity)

As discussed above, return on equity is influenced by profitability, efficiency and leverage. Therefore, the next set of screens seek companies outperforming their peers in these areas. First, the AAII Return on Equity approach requires that a firm’s net margin (net income divided by sales) exceed the industry median over the last four quarters (trailing 12 months). Net profit margin looks at bottom-line profitability. Firms exceeding their peers are translating a higher percentage of sales into profits.

Next, the AAII Return on Equity screen makes sure that the asset turnover (sales divided by total assets) for a firm exceeds the industry median over the last four quarters. Asset turnover helps to measure the efficiency of a firm’s use of its asset base. Firms exceeding their peers are generating higher levels of sales dollars for a given level of assets.

The AAII Return on Equity approach also specifies that when looking at the financial leverage of firms, the ratio of total liabilities to total assets at the end of the most recent quarter is below the industry median. A high return on equity can be attained by having a very high amount of debt and, therefore, a very low shareholder’s equity. In such a case, return on equity would be high, but risky. Financial leverage increases return but also increases risk. Highly leveraged firms have more volatile earnings. Acceptable levels of debt vary from industry to industry. More stable industries such as utilities can comfortably carry more debt on their balance sheets than volatile industries such as oil and gas. By comparing levels of liabilities to industry medians, the AAII Return on Equity screen takes industry differences into account.

To help ensure some basic level of growth, the AAII Return on Equity strategy requires positive earnings and sales growth over the past 12 months. The approach also requires that the firm’s five-year historical growth rates in earnings and sales exceed their respective industry medians. The approach does not specifically look for high absolute levels of growth, just signs that the firms are expanding faster than their peers.

The AAII Return on Equity screen also requires that a stock be listed on an exchange to help ensure trading liquidity. Therefore, stocks that trade over the counter (OTC) are excluded. Due to their special nature, the AAII Return on Equity screen also excludes real estate investment trusts (REITs), closed-end funds (CEFs) and American depositary receipts (ADRs).

The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

If you want an edge throughout this market volatility, become an AAII member .

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• Published: 11 May 2023

Allocating capital-associated CO 2 emissions along the full lifespan of capital investments helps diffuse emission responsibility

• Quanliang Ye   ORCID: orcid.org/0000-0002-6135-3403 1 , 2 , 3 ,
• Maarten S. Krol 1 ,
• Yuli Shan   ORCID: orcid.org/0000-0002-5215-8657 4 ,
• Joep F. Schyns   ORCID: orcid.org/0000-0001-5058-353X 1 ,
• Markus Berger 1 &
• Klaus Hubacek   ORCID: orcid.org/0000-0003-2561-6090 2  

Nature Communications volume  14 , Article number:  2727 ( 2023 ) Cite this article

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Capital assets such as machinery and infrastructure contribute substantially to CO 2 emissions over their lifetime. Unique features of capital assets such as their long durability complicate the assignment of capital-associated CO 2 emissions to final beneficiaries. Whereas conventional approaches allocate emissions required to produce capital assets to the year of formation, we propose an alternative perspective through allocating required emissions from the production of assets over their entire lifespans. We show that allocating CO 2 emissions embodied in capital assets over time relieves emission responsibility for the year of formation, with 25‒46% reductions from conventional emission accounts. This temporal allocation, although virtual, is important for assessing the equity of CO 2 emissions across generations due to the inertia of capital assets. To re-allocate emission responsibilities to the future, we design three capital investment scenarios with different investment purposes until 2030. Overall, the existing capital in 2017 will still carry approximately 10% responsibilities of China’s CO 2 emissions in 2030, and could reach more than 40% for capital-intensive service sectors.

Introduction

Substantial government and private investments in capital assets such as power plants, machinery, and infrastructure have enabled global fast-growing economic activities 1 , 2 . Capital investments account for around one quarter of global gross domestic product (GDP) since 1970 3 . In some developing countries, for instance China, capital investments could account for up to 47% of its national GDP, with an annual average growth rate of 12% since 1995 3 . Building up capital assets requires considerable resource inputs and generates pollution 4 . For instance, 156 gigatons (Gt) of carbon dioxide (CO 2 ) have been emitted to produce global capital assets invested between 1995 and 2015, accounting for 32% of global total CO 2 emissions during the same period 5 .

Two unique features of capital assets, different from non-capital products, complicate the assignment of capital-associated CO 2 emissions to final capital beneficiaries, and thus require capital-oriented methods (as complements of conventional production- 6 , 7 and consumption-based approaches 8 , 9 ) for the assignment. First, capital assets are invested and used by economic sectors for productive purposes. Between the initial investment and production-oriented use phase, capital assets are produced by capital-producing (so-called ‘capital formation’ in national accounting) sectors. This feature raises arguments about how to allocate CO 2 -emission responsibilities of capital activities 10 , 11 , 12 , 13 , 14 , to producers, or to users, or to final consumers of products that are produced by using associated assets. Second, capital assets can exist for several years or even decades, and serve economic production throughout their lifespans. This feature implies that future production and consumption will induce not only economic inputs and emissions in the future, but also depend on already-existing capital assets and embodied emissions that occurred in the past as long as the capital is used. It hence leads to the temporal allocation of emission responsibilities of capital activities along capital’s full lifespan.

Little is known about the second feature of capital assets and its impacts on the allocation of environmental pressures along capital’s lifespan. Literature has investigated the geospatial displacement of environmental pressures along supply chains, and allocated them from producers to final consumers, yielding consumption-based environmental pressures 8 , 9 . Due to aforementioned two features of capital, how to treat the purchase of capital assets and allocate associated environmental responsibilities is still debated. In conventional analysis, capital assets are treated in the same way as products for final consumption, allocating environmental pressures that occurred during the production of capital assets to the purchasing sectors and countries 4 , 8 , 9 . Recently, studies treated capital as one production factor (i.e., as intermediate inputs for economic production), and allocated capital-associated environmental pressures to final consumption across sectors and countries 12 , 13 , 14 . Particularly, Chen et al. 11 considered the dynamic of capital investment and depreciation in national greenhouse gas (GHG) emission assessment for a single year 2009. However, the intertemporal features of capital assets remain unaddressed (see the comparison of existing capital-oriented methods in Supplementary Information Table S 1 ), neglecting that capital assets used for year n ’s production are from different time cohorts—produced based on different production recipes, trade networks, and environmental intensities. This neglect has been found to result in an approximate 30% underestimation in capital-associated GHG emissions 12 .

To properly understand this important temporal dimension of environmental responsibility displacement requires a full picture of capital flows across sectors and regions (according to the first feature) and also throughout its lifespan from the past to the future (according to the second feature). This study presents a comprehensive analysis of capital development and quantifies temporal CO 2 displacement along capital production, trade and use over the period of 1995—2017 as well as under capital investment scenarios for the near future until 2030. We first develop an inter-provincial capital-endogenized multi-regional input-output (MRIO) model to link provincial capital depreciation to the production side of capital using sectors, and subsequently to the consumption side of final products of each province (Methods). Second, to understand the temporal dimension of CO 2 displacement from the past to the future, we design China’s future capital investment pathways by a ‘business-as-usual’ (BAU) scenario and two alternative capital-oriented scenarios until 2030 (Methods). One of the capital-oriented investment pathways is developed on the principle of improving economic growth and social well-being (KES, here ‘K’ standing for capital), under which China is increasingly focusing on the role of capital assets, especially infrastructure related to transportation and communications. The other pathway is based on the principle of low-carbon development (KLC), under which China’s future capital investment are required to focus on low-carbon technologies by the electricity generation sector and end-use sectors such as transportation services. We quantify spatiotemporal CO 2 displacement embodied in capital flows among sectors, across provinces, and over time. We show that temporally displaced CO 2 emissions along capital’s full lifespan take a large share in total emissions of China, and capital-intensive service sectors. This temporal displacement, although virtual, is also important for assessing the sustainability and efficiency of national resource use especially in developing countries, which may have capital investment booms during short periods, and the equity of resource use across generations.

Monetary capital flows and embodied CO 2 emissions over time

Distinguishing capital formation from capital investment and use is a prerequisite to understand the full lifespan of capital. Monetary capital flows (Fig.  1a ) start from capital-investing sectors (i.e., sectors undertaking the investment to build up their capital stock) to capital-producing (i.e., capital formation) sectors, and end in capital-using sectors (i.e., the original investing sectors) for production to satisfy final demand. Real estate services, transportation services, electricity generation, and residential services are the main capital-investing sectors in China, which together accounted for half of total capital investment during the period of 1995−2017. Information of annual capital formation is recorded as gross fixed capital formation (GFCF) in the national accounts, which show that construction (contributing 58% of total GFCF), general equipment manufacturing (7%), and transportation equipment manufacturing (5%) dominated China’s capital formation over the time period 1995−2017. As such, main flows from capital investment to formation are observed among these key capital investing and producing sectors. Capital-using sectors will take over capital assets produced by capital-formation sectors for their productive purposes over years. We find that approximately one-third of all the capital assets formed during 1995–2017 have been depreciated to produce final consumption (14%), fixed capital (12%), and international exports (6%) by 2017. The remaining assets are still effective for future economic activities. Based on the three capital scenarios developed in this study, we show that another third (31%) of the capital assets formed in 1995−2017 would be depreciated between 2018 and 2030.

a Monetary capital flows across key sectors of China’s capital development. An example to understand different terms of capital in ( a ): the transportation services sector investing in transportation equipment (e.g., vehicles) is regarded as ‘capital investment’; the manufacturing sector producing vehicles is regarded as ‘capital formation’; the transportation services sector using vehicles is regarded as ‘capital use’; during the use of vehicles, the annual decline of the total value of vehicles is regarded as ‘capital depreciation’. A time difference between capital investment and use should be also noted. Compared to equipment like vehicles, this time difference is more critical for infrastructure and buildings that takes years to be built before being used by the investors.  b Embodied CO 2 transfers across key sectors of China’s capital development. The cumulative amounts of capital investment and embodied CO 2 emissions between 1995 and 2017 are shown in the plots. Capital-related flows for the period 2018−2030 are shown as average flows of all three scenarios developed in this study. Seven key sectors highly relevant for China’s capital development are selected in the plots. Full names of sectors can be found in Table S 6 .

Our study reveals that conventional estimations of supply chain-wide CO 2 emissions (i.e., consumption-based CO 2 emissions, CBE) embodied in ‘capital investment’ are, to some extent, misleading the allocation of capital-associated emission responsibilities to capital producers instead of capital users. Sectors that mainly contribute capital-associated emission flows are the same as those in the monetary flows (Fig.  1b ). That is, the construction sector took the largest share in CBE of capital formation ( CBE GFCF , Methods), accounting for 68% of total CBE GFCF during 1995–2017. This result is consistent with previous findings regarding CBE of GFCF sectors 9 , 15 . As for supply chain-wide CO 2 emissions embodied in depreciated capital ( F K , Methods), real estate services, transportation services, and residential services are the main contributors. F K can also be allocated to final goods and services until 2017, between 2018 to 2030, and for long-term future production after 2030, which account for 35%, 33%, and 32%, respectively, of total CBE GFCF during 1995–2017. It is important to note that supply chain-wide CO 2 emissions embodied in capital investment and use have rarely been estimated for actual investing sectors. Previous supply chain-wide CO 2 emissions of ‘capital investment’ were calculated for capital formation sectors, i.e., CBE GFCF 9 , 15 . As shown in Fig.  1a , capital investing sectors―the final users of capital assets―are different from capital formation sectors. Therefore, a misallocation of capital-associated emission responsibilities to capital producers instead of capital consumers is revealed in conventional input-output table-based estimates of supply chain-wide CO 2 emissions of ‘capital investment’. When re-allocating this part of capital-associated CO 2 emissions to the actual capital consumers or further to final goods and services throughout the full lifespan of capital, it would substantially alter CO 2 emission accounting at both regional and sectoral levels.

Capital re-allocation altering regional CO 2 emission accounts

How we assign capital-associated CO 2 emissions substantially alters regional CO 2 emission accounts from both production and consumption perspectives (Fig.  2 ). Conventionally, we treat capital assets the same way as non-capital goods, and assign capital-associated CO 2 emissions to the producing region yielding production-based CO 2 emissions (PBE) of GFCF or to the purchasing region yielding CBE of GFCF. In this study, we treat capital assets as production inputs by endogenizing capital investment and consumption into economic production over time and across provinces (Methods), and re-allocate supply chain-wide CO 2 emissions embodied in annual capital depreciation ( F K ) to capital using sectors for production-based accounting or to final demand for consumption-based accounting.

a National PBE with (PBE K , represented by the orange dashed line) and without (conventional PBE, represented by the red solid line) the re-allocation of capital-associated CO 2 emissions ( F K ), as well as the national CBE with (stacked grey, purple and light purple areas) and without (i.e., the conventional CBE, represented by the black solid line) the re-allocation of F K . b Changes in regional per-capita PBE and CBE for the year 2017 with and without the re-allocation of F K . The geographical partition of China can be found in Table S 4 . c Inter-provincial inequality of per-capita PBE and CBE in 2017 with and without the re-allocation of F K . The gray dashed line represents the perfect equality of per-capita CO 2 emissions.

National PBE and CBE after F K re-allocation (denoted as PBE K and CBE K ) are lower than conventional PBE and CBE (Fig.  2a ). The reason is that only one-third of the CO 2 emissions embodied in GFCF occurring during 1995‒2017 would be assigned to economic production over the same period (Fig.  1b ). From a production perspective, compared with conventional PBE, national PBE K would be 25‒35% lower since 1995. The decrease in national PBE implies that conventional PBE of GFCF in a certain year is still larger than cumulative F K from 1995 to that year for production of capital using sectors. The changes would even be larger from a consumption perspective with 31‒46% decrease from conventional CBE. We also observe that the relative changes in recent years from conventional emission accounts to our capital-endogenized accounting method are generally smaller than those in the early years around 1995. Economic growth needing more capital inputs is one reason, whilst neglecting pre-1995 capital investment and their CO 2 emissions (due to lacking data) for current production is another. Our estimates of capital consumption and embodied F K are conservative, especially for the early years in our modeling period (e.g., year 1995). For later years, the impacts of neglecting pre-1995 capital investments become much smaller. Starting with 2013, less than 1% of the F K was allocated from CO 2 emissions embodied in capital goods invested in 1995.

Changes are also observed in per-capita CO 2 emissions and inter-provincial inequality due to re-allocating capital-associated CO 2 emissions. Similar to changes in national PBE and CBE, regional per-capita PBE K and CBE K also decline compared with conventionally accounted emissions (Fig.  2b ). Changes in per-capita CO 2 emissions vary widely among regions for the year 2017, especially per-capita PBE. The per-capita PBE K are observed with a range of 15‒38% reduction from the conventional per-capita PBE in 2017 (detailed percentage changes are listed in Table S 9 ). The Northwest, the North, and the Northeast have relatively larger reduction in their regional per-capita PBE, compared with more developed regions such as Beijing-Tianjin and the Central Coast. Yet, these northern regions only invested around 28% of the total capital formation in 2017. We also observe that changes in per-capita PBE to PBE K are consistent with regional changes from conventional per-capita PBE to CBE. Thus, to explain the relatively larger changes in per-capita PBE in these northern regions, their net-exporting roles of capital assets and embodied CO 2 emissions may be the main reason. In contrast, the relatively larger changes in per-capita CBE are found in the regions having more capital investment, such as the Central (−36%) and the Southwest (−36%) which contributed 28 and 17%, respectively, of national total GFCF in 2017. Lastly, our results also reveal that capital re-allocation would decrease inter-provincial inequality of per-capita PBE, but also to some extent increase the inequality of per-capita CBE (Fig.  2c ).

Conventional PBE and CBE under different capital-investment scenarios

To reveal the full lifespans of capital assets from the past to the future, future production and use of capital in China are projected by a ‘business-as-usual’ (BAU) scenario and two capital-oriented pathways (i.e., KES and KLC scenarios) that focus on different purposes of capital investment (Methods). Conventional PBE and CBE of China would substantially increase under the BAU and KES scenarios (Fig.  3a ) but would only show modest growth (less than 2%) under the KLC scenario. The national PBE in 2030 (Fig.  3b ) would increase by 15% under the BAU scenario from the base-year level, and by 20% under the KES scenario because more investment will be made in infrastructure for economic growth and improvement of social well-being. The main growth in national PBE under the BAU and KLC would be observed in material manufacturing sectors (Fig. S 3 ) which provides materials such as cements for infrastructure construction and metal products for machinery production. The growth of national PBE would also be offset by CO 2 emissions from electricity generation (Figure S 3 ) given the efficiency improvement and mix changes in energy production and use. From the consumption perspective, similar growth rates would also be found in national CBE of final consumption and final demand (Fig.  3b ) while the main growth is observed in the construction sector due to the formation of fixed capital and transportation services due to increasing demand (Fig. S 7 ). Uncertainty analysis shows that national CO 2 emissions in 2030 would have the largest fluctuation of −4‒6% under the KES scenario (Fig.  3a ). Moreover, compared with the BAU scenario, an extra 7% of investment in low-carbon technology under the KLC scenario would gain a 9% reduction in national PBE, but would also result in a 4%-decrease in national GDP. In addition, at the regional level, potential decreases in provincial PBE and CBE in 2030 could be expected in some regions such as Beijing-Tianjin, and the Southwest (Fig. S 2 ). Detailed analysis of future projections of conventional PBE and CBE of each region can be found in Supplementary Information  3 .

a National CO 2 emissions of China under different scenarios. Colored areas represent the 25th–75th percentile of the results of the uncertainty analysis. b National CO 2 emissions and gross domestic product (GDP) for 2017 and 2030 under different scenarios. Re-allocated CO 2 emissions embodied in capital depreciation ( F K ) are disaggregated into those that occurred in the period 1995−2017 (with solid purple edge line) and those that would occur in the period 2018−2030 (with dashed purple edge line).

‘Historically committed’ CO 2 emissions for future production and consumption

When continuing allocating F K that occurred during the period 1995−2017 to economic production and consumption in the near future, our results show that approximately 10% of national CO 2 emissions (represented by PBE K or CBE K ) in 2030 would be based on CO 2 embodied in capital investments during 1995−2017 (Fig.  3b ). This share of pre-2017 F K in national CO 2 emissions would be even higher in 2018 and 2019, accounting for 23−30%, since the re-allocated F K from a certain year decreases along the lifespans of assets (Fig. S 4 ). The total share of F K (including both pre-2017 emitted and future emissions between 2018 and 2030) in national PBE K and CBE K would be respectively 32−34% and 37−39% in 2030, and both have ±2% fluctuations based on the uncertainty analysis.

We regard this part of capital-associated emissions (i.e., re-allocated F K ) that occur before a certain year n but are finally allocated to economic production and consumption in year n as ‘ historically committed ’ CO 2 emissions. The ‘ historically committed ’ CO 2 emissions have some differences from future ‘committed’ CO 2 emissions that were estimated by Davis et al. 16 and Tong et al. 17 . The future ‘committed’ CO 2 emissions look forward at the expected CO 2 emissions after year n by operating existing fossil fuel-burning infrastructure by year n . Our ‘ historically committed ’ CO 2 emissions look backward at how much of the historically emitted CO 2 that was embodied in existing capital assets by year n should be attributed to economic production and consumption in year n , as they rely on these historically formed capital assets. Based on the three capital scenarios, this study extends the analysis of spatiotemporal downstream impacts of capital development on regional CO 2 emission accounting, and indeed quantify both historically and future ‘committed’ CO 2 emissions of all economic sectors, while the previous future ‘committed’ CO 2 emissions were only estimated for the power generation sector 16 , 17 .

Contributions of historically and future ‘committed’ CO 2 emissions to sectoral CO 2 emission (represented by PBE K or CBE K ) vary widely in our analysis. Table  1 summarizes historically and future ‘committed’ CO 2 emissions of four capital-intensive production sectors in 2030 under each scenario. We find that most CO 2 emissions of the electricity generation and supply sector are future ‘committed’ emissions, as highlighted in previous studies 16 , 17 , whereas ‘ historically committed ’ CO 2 emissions of its production and consumption are relatively small (only accounting for 4–6%). In contrast, ‘ historically committed ’ CO 2 emissions of service-related sectors would occupy a large share of their future CO 2 emissions. Particularly for real estate services and residential services, ‘ historically committed ’ CO 2 emissions would dominate their future CO 2 emissions from both production and consumption perspectives, accounting for more than 83% of their CO 2 emissions. The remaining emissions are attributable to economic activities of real estate services in the year 2030. This figure is in line with the 77%-86% range of changes for carbon footprints of residential housing, found by Berrill et al. 18 , based on a capital-endogenized model of the United States. Transportation services would have less difference between its historically and future ‘committed’ CO 2 emissions, compared with other sectors, and would have more future ‘committed’ emissions (contributing more than 60%) in 2030. Furthermore, ‘ historically committed ’ CO 2 emissions from 1995−2017 would take the largest share in CO 2 emissions of China and most sectors in 2030 under the KLC scenarios. This is because cleaner production under the KLC scenario would reduce associated CO 2 emissions of production and consumption in future, which hence enlarges the share of historical CO 2 emission embodied in capital production that relied on lower-efficient production technologies. Our results suggest that the earlier development of efficient productive capital would bring less CO 2 emissions of future production, as observed in developed countries such as the United States and Japan 15 , 19 .

The two features of capital assets raise two important topics of analyzing capital activities and their environmental responsibilities. One is the allocation of environmental responsibilities across different capital activities such as capital formation or capital use, the other is temporal displacement of environmental responsibilities along capital’s lifespan. The first topic has been explored by endogenizing capital into MRIO modelling 10 , 11 , 12 , 13 , 14 , while the second topic has not received much attention. This study explores the second issue and demonstrates an approach to quantify and allocate supply chain-wide capital inputs and associated CO 2 emissions among sectors, across regions, and over time. ‘ Historically committed ’ CO 2 emissions are defined in this study. ‘ Historically committed ’ CO 2 emissions provide a scheme to assign emission responsibilities of capital activities over time. This over-time accounting scheme allocates capital-associated emission responsibilities to capital users instead of capital producers as conventionally done. Furthermore, this over-time accounting scheme allocates emissions of capital formation from the year of formation over capital’s entire lifetime, which relieves emission responsibility for the year of formation yet indeed entails a delay in carbon mitigation. Learning from economic loans or mortgages (used to purchase products in a certain year but paid back over time), the idea of mortgages of emission burdens—emitted during construction but complemented with emission-neutrality measures throughout the payback period to offset emission burdens of the formation year—can reduce the impacts of the delay. This mortgage idea of emission burdens is hence in line with the concept of carbon neutrality. In addition, mortgages of emission burdens are more relevant to investment plans of capital-intensive but climate-friendly projects such as infrastructure for any renewables, if current huge emission burdens are an important concern to launch such projects. There is also a need to avoid climate-unfriendly projects to adopt this mindset and could use it for greenwashing purposes when applying the mortgage idea of emission burdens. Our findings suggest to decision-makers to pay attention to this inertia of capital assets in terms of historic and future ‘committed’ environmental pressures when making capital investment plans and designing capital-related policies.

Capital assets influence the attainment of all of the Sustainable Development Goals 2 . However, there are only few studies that systematically project future capital development and even less that analyze supply chain-wide downstream environmental pressures. This study fills this important research gap through developing the BAU, KES, and KLC scenarios to compare China’s future capital development pathways and associated CO 2 emissions. China has promised to peak its CO 2 emissions by 2030. To achieve this target, it is projected that China’s energy and CO 2 intensity levels need to decline by 43 and 45%, respectively 20 . This indicates that a substantial amount of investments in low carbon technologies are expected in the near future, and associated CO 2 emissions are mostly in the capital investment rather than the use phase. The KLC scenario presents an alternative pathway for China low-carbon development via efficiency improvement and energy transition. Results show that low-carbon technology investments designed in the KLC scenario would be cost-efficient at the national scale―an extra 7% of low-carbon technology investments would gain a 9% decline in national CO 2 emissions compared with the BAU scenario―and in most provinces. In addition, we find that ‘ historically committed ’ CO 2 emissions are mostly attributable to the production and consumption of capital-intensive service sectors (Table  1 ), which are usually not regarded as main CO 2 emitters. Failing to include this ‘ historically committed ’ part of CO 2 emissions in CO 2 emission accounting especially of service sectors hence strongly underestimates their contributions. Recent news indicates that in light of the COVID-19-induced slump in the world economy 21 and the Russia-Ukraine war 22 , China has further stimulated investment, mostly in the service sectors, energy, and food products. The endogenization of capital is an additionally necessary step to ensure that policy makers realize the synergies and trade-offs between capital-intensive economic development and associated environmental burdens, to avoid any ‘lock-in’ effects 23 on carbon emissions or resource requirements and pursue a cost-efficient pathway of economic recovery like the one demonstrated in the KLC scenario instead of the KES scenario.

China has launched its first national emissions-trading scheme on 16 July 2021 24  with a focus on direct emissions. The direct emissions of electricity generation sector in the future, regarded as future ‘committed’ emissions 16 , 17 , have been found as its main CO 2 emissions (Table  1 ) compared to the ‘ historically committed ’ emissions. However, the choice of conventional emission accounting or the accounting scheme over time considering capital-associated CO 2 emissions influences the accounted emissions considerably (Fig.  2 and Table  1 ), which will finally determine the emissions allowances of each plant in the emissions-trading market. For instance, using the CO 2 accounting scheme proposed in this study, an average 30% reduction from conventional PBE of energy sector in 2030 was found under different capital scenarios (Table  1 ). The changes in emission allowances cannot be specified based on the current study but could result from a similar dedicated scenario study. Nevertheless, we provide suggestions for policy makers to consider capital-associated emissions in China’s emissions-trading market, particularly for energy plants: (1) constructing a systematic database 25 that covers the lifetime of each device (start, retired or ceased operating date), fuel types, and generating capacities, which determine the emissions during the operating phase; (2) developing a standard accounting method to quantify capital inputs at high resolution of assets especially for power plant structures, generating devices, and transmission lines 26 , which reflect indirect emissions related to capital inputs, that is, ‘ historically committed ’ emissions; and (3) formulating a fair price mechanism for both historic and current emissions for companies to trade their emission allowances, which help take into consideration both emissions that are related to energy plants and their roles in the emissions-trading market.

Developing capital database and constructing capital depreciation flows

Official capital investment data from the National Bureau of Statistics of China (NBSC) are recorded by two main annual series, ‘total investment in fixed assets (TIFA)’ and ‘newly increased fixed assets (NIFA)’. TIFA refers to the ‘workload’ of activities in construction and purchases of fixed assets in monetary terms, which may not produce results that meet standards for fixed assets in the current period or may take many years to become qualified for fixed assets 27 . NIFA refers to the value of investment projects completed and put into production or meeting the standards for fixed assets in the current year, hence reflecting the fixed assets formed in the current period as a result of those effective investment projects taking place in the current and previous periods. Given that the concept of ‘capital investment’ used in the perpetual inventory method (PIM), a standard geometric method that is adopted in this study to calculate capital consumption time series, are those effective capital assets that have been completed and put into production, this study relies on NIFA to construct the provincial capital investment time series. More details about the differences between TIFA and NIFA and the problem of directly using TIFA in PIM are discussed in Supplementary Information  6 .

Although NIFA (denoted as N , in Yuan per year) is more reasonable than TIFA to be used as capital investment (denoted as I , in Yuan per year) in PIM, an upward adjustment has to be made to transfer N to I . This upward adjustment is to include the projects less than half million yuan by non-state firms that are not reported in official investment statistics plus the value of likely underreported 28 . The standard I by sector s of province m in year t could be estimated as:

where λ is to adjust N by the effects of missing and/or underreported investment. There is little information available on λ especially those at provincial level. We apply the national \({\lambda }_{t,s}\) from Wu 29 to adjust N m,t,s , and further scale N m,t,s into the national capital investment by sector s in year t from WORLDKLEMS. We also specify 37 sectors (Table S 3 ) in our provincial capital investment dataset, which are consistent with the sectoral classification in WORLDKLEMS.

There are limited investment data by asset type especially at industrial level. In the official investment statistics, under the subcategories of TIFA ‘capital construction’ and ‘technical update and transformation’, there are data for ‘equipment’ and ‘structures’. The ‘structures’ indicator also distinguishes ‘housing’ or ‘non-productive’ constructions. We rely on TIFA by these categories (although they are not directly relevant with NIFA), and industrial investment statistics in annual statistics bulletins 30 about industry and transportation economy, commune and brigade factories, and township and village enterprises to disaggregate the capital investment. According to Wu 29 , this study also disaggregates four categories of industry-specific fixed assets, namely, ‘equipment’, ‘residential structures’, ‘non-residential structures’ and ‘others’. We re-allocate ‘others’ into ‘equipment’ and ‘non-residential structures’ by a ratio of 3:7 according to Wu 29 . Without category-specific data on investments in non-industrial sectors (i.e., agriculture, construction, and all services), we assume that the non-industrial sector-specific I is equal to the official NIFA of that sector. We use the share of productive structures given by the economic-wide TIFA to decompose the total investment into non-residential structures and equipment.

The procedures to trace and allocate the contribution of year t ’s capital investment to year n ’s inter-industrial production networks follow the global capital endogenized MRIO model 14 . In this study, we develop a Chinese version of the capital endogenized MRIO model (details about the procedures can be found in Supplementary Information  9 ). This Chinese version relies on the inter-provincial MRIO tables of China and focuses on the impacts of capital development in China on the emission responsibilities of provinces across China. The international import and export linked to other countries are aggregated in the MRIO tables of China. The key step to obtain the supply chain-wide capital consumption matrix \({{{{{{\bf{D}}}}}}}_{t,n}^{K}\) ( t ≤ n , in Yuan) within China is re-creating the concordance tables that are used to convert capital assets and capital consumption sectors (37 sectors, Table S 3 ) into the sectoral classifications of MRIO tables (42 sectors, Table S 6 ). The final capital consumption matrix \({{{{{{\bf{D}}}}}}}_{t,n}^{K}\) within China has capital producing and capital consuming sectors along rows and columns, respectively; and each element records the quantity of assets that were invested in year t and consumed (i.e., depreciated) in year n . It should be noted that the capital flows showed in Fig.  1a are in the unit of 2017 US dollars. We rely on the price indices like currency convert rates, consumption price index of US dollars obtained from The World Bank to convert Yuan to 2017 US dollars.

Constructing China’s inter-provincial MRIO table series (1995−2017)

We rely on the current best available MRIO tables in 2007 31 , 2010 32 , 2012 33 , 2015 and 2017 from CEADs 34 , 1995−2006 from Wang 35 as the benchmarks to construct the inter-provincial MRIO table time series. Before that, we first adjust the final demand, exports, imports and value-added data in the benchmarking MRIO tables, according to the available statistical data from the NBSC. This is because we found that some benchmarking MRIO tables have big data gaps based on available statistical data, especially for early years. We rebalance these benchmarking MRIO tables using the GRAS method 36 , and use the benchmarking MRIO tables to estimate the MRIO table in the missing years. Details about estimating final demand, exports, total outputs, and using the GRAS method to balance the MRIO tables in the target years can be found in Supplementary Information  8 .

Re-allocating capital-associated CO 2 emissions ( F K )

The supply chain-wide CO 2 ( \({{{{{{\bf{F}}}}}}}_{t,n}^{K}\) , in tonnes) that emitted in year t when the capital inputs allocated to year n ’s production activities (i.e., \({{{{{{\bf{D}}}}}}}_{t,n}^{K}\) ) can be estimated by conventional IO modelling, \({{{{{{\bf{F}}}}}}}_{t,n}^{K}=\hat{{{{{{{\bf{S}}}}}}}_{t}}{{{{{{\bf{L}}}}}}}_{t}{{{{{{\bf{D}}}}}}}_{t,n}^{K}\) , where S t (in tonnes per Yuan) is a row vector of direct CO 2 emission intensities of economic activities, collected from CEADs 37 , 38 , 39 ; L t (Yuan per Yuan) is the Leontief inverse matrix 40 . When allocating \({{{{{{\bf{F}}}}}}}_{t,n}^{K}\) to the actual capital using sectors in year n , we can obtain production-based emissions of capital depreciation in year t for year n ’s production. The allocation of \({{{{{{\bf{F}}}}}}}_{t,n}^{K}\) to capital using sectors as production-based emissions follows the conventional logic of production-based emission assignment (details see Supplementary Information  15 ). When allocating \({{{{{{\bf{F}}}}}}}_{t,n}^{K}\) to final consumption ( \({{{{{{\bf{Y}}}}}}}_{n}^{{FC}}\) , including final expenditure of rural population, urban population, and government, in Yuan), gross fixed capital formation ( \({{{{{{\bf{Y}}}}}}}_{n}^{{GFCF}}\) , in Yuan), and international exports ( \({{{{{{\bf{Exp}}}}}}}_{n}\) , in Yuan) in year n , we can obtain capital-associated consumption-based emissions in year t for different economic activities in year n (Eqs.  2 – 4 ).

where \({{{{{{\boldsymbol{S}}}}}}}_{t,n}^{K}\) (in tonnes per Yuan) describes the one-unit CO 2 emissions of province-sector pairs in year t that consumed \({{{{{{\bf{D}}}}}}}_{t,n}^{K}\) in year n , calculated by \({{{{{{\bf{S}}}}}}}_{t,n}^{K}=\varphi {{{{{{\bf{F}}}}}}}_{t,n}^{K}{\hat{{{{{{{\bf{x}}}}}}}_{n}}}^{-1}\) , in which x n (in Yuan) is a column vector of total economic outputs of year n , and φ is a summation vector of ones.

Re-assessing CO 2 emissions of provinces

Different from conventional emission accounting of capital activities (represented by consumption-based CO 2 emissions of GFCF in one-year base, \({{CBE}}_{t}^{{GFCF}}={{{{{{\bf{S}}}}}}}_{t}{{{{{{\bf{L}}}}}}}_{t}{{{{{{\bf{Y}}}}}}}_{t}^{{GFCF}}\) , in tonnes), we re-allocate \({{CBE}}_{t}^{{GFCF}}\) to the actual capital using sectors or further to the final demand throughout the assets’ lifespans according to annual \({{{{{{\bf{F}}}}}}}_{t,t}^{K}\) , \({{{{{{\bf{F}}}}}}}_{t,t+1}^{K}\) , \({{{{{{\bf{F}}}}}}}_{t,t+1}^{K}\) , … This re-allocation of F K hence changes annual CO 2 emission accounting of provinces from both production-based and consumption-based accounting (i.e., consumption-based CO 2 emissions of final demand, \({{{{{{\bf{S}}}}}}}_{n}{{{{{{\bf{L}}}}}}}_{n}({{{{{{\bf{Y}}}}}}}_{n}^{{FC}}+{{{{{{\bf{Y}}}}}}}_{n}^{{GFCF}}+{{{{{{\bf{Exp}}}}}}}_{n})\) ). Two steps are taken to re-assess provincial CO 2 emissions. One is omitting the conventional PBE and CBE that are related to GFCF of a province. The other is adding back F K re-allocated to capital using sectors generating PBE after F K re-allocation (PBE K ), or adding back F K re-allocated to final demand generating CBE after F K re-allocation (CBE K ). Units of PBE, CBE, PBE K , and CBE K are tonnes.

Developing scenarios of capital investment until 2030

We project China’s capital investment pathways by two scenarios into 2030, and a ‘business-as-usual’ (BAU) scenario as the baseline scenario. The two capital investment pathways are developed on the principle of improving economic growth and social well-being (KES), and the principle of low-carbon development (KLC), respectively. All three scenarios are in constant prices of year 2017 and developed based on the economic activities and CO 2 emissions in 2017 as the base year. We assume that the national average capital intensity of one-unit GDP is the same for each scenario. All the scenarios will be implemented by manipulating the MRIO tables of the year 2017 to each projecting year. Details of each scenario are summarized in Table S 7 .

The BAU scenario, referred to De Koning et al. 41 , is developed by continuing historical trends of population growth, efficiency improvements, and productivity growth until 2030 (summarized in Table S 8 ). The trends in general efficiency improvement (influenced by current economic and climate policies) into 2030 are determined by actual trends in the last decade, looking in detail at sector- and province-specific development (recorded in A ). If we assume total outputs in a projected future year would not change, efficiency improvements reduce intermediate inputs (including domestic inputs and imported inputs) for economic activities and further lead to substantial economic growth. We then make up the difference to meet overall GDP growth (recorded in vd ) based on the autonomous economic growth accomplished by efficiency change. GDP growth rates are set as 6.5% per year before 2020, and 5% per year after 2020 42 , 43 . Final consumption of rural and urban population (recorded in Y FC ) is estimated based on projected population, urbanization rates, and per-capita expenditures. Rural and urban population in each province until 2030 are estimated using total provincial population and national urbanization rate, obtained from Chen et al. 44 . Per-capita final expenditure of rural and urban population until 2030 are estimated by the same method used in previous studies 45 , 46 . Final consumption of government is estimated according to the total changes in the final consumption of rural and urban population. Capital investment of sectors is estimated according to required future capital stock of each sector. We first predict the capital stock intensity of value-added of each sector in 2030, based on its capital stock intensity in the base year, elasticity parameter, and changes in capital price 47 . Total capital stock of each sector in 2030 can be calculated by multiplying the capital stock intensity with its total value-added. Annual average capital investment until 2030 can be calculated by the PIM, given that the capital stock in year T equals to \({\sum }_{t}^{T}I{(1-\delta )}^{T-t+1}\) , where \(\delta\) is the depreciation rate of each asset. After that, we distribute the capital investment of each investing sector to capital producing sectors, based on the capital production structure in 2017, to obtain Y GFCF in target year. International export is assumed to proportionally increase according to growth of GDP. Total outputs, intermediate inputs, and international imports for intermediate inputs in the target year can then be calculated by the basic equations of IO modelling. We balance total inputs and outputs through GRAS method (Supplementary Information  8 ). Furthermore, we adjust the balanced MRIO tables according to the changes in energy mix (Figure S 6 ). The total energy supply and use are consistent with the projections in IEA 48 . Changes in energy supply and use per source (i.e., coal, oil, natural gas, nuclear and renewable energy) lead to proportional changes in the transactions with associated sectors (e.g., coal mining). We also adjust the intermediate inputs from different energy sources to electricity generation sectors according to the changes in their shares in total power generation. The adjusted MRIO tables are balanced again using GRAS method. Direct CO 2 emissions from sectors are changed as well (recorded in F ). It is assumed that the changed intermediate inputs in sectors bring changes in emissions accordingly.

Under the KES scenario, China is increasingly focusing on the role of capital assets, especially infrastructure, to improve economic growth and social well-being 49 . We rely on the associated outlook of infrastructure development in China (summarized in Table S 8 ) from GIH 1 , and integrate future infrastructure investment data into the MRIO model for CO 2 emission accounting. Seven infrastructure categories are covered in this scenario, i.e., roads, railways, airports, seaports, electricity generation and supply, water generation and supply, and telecommunications. The KES scenario is developed on top of the BAU scenario. We first determine the sectors that invest in the associated infrastructure. That is, we assume roads, railways, airports, and seaports are mainly based on investments by the sector ‘ Transportation, storage and post services ’, electricity/water generation and supply are invested by the sector ‘ Production and supply of electricity, heat, gas, and water ’, and telecommunications are invested by the sector ‘ Information transfer, software and information technology services ’. According to statistical data recorded in NBSC 50 , investments in roads, railways, airports, and sea ports annually account for approximately 94% of total investment from ‘ Transportation, storage and post services ’, investment in electricity/water generation and supply accounts for approximately 97% of total investment from ‘ Production and supply of electricity, heat, gas, and water ’, and investment in telecommunications annually accounts for approximately 92% of total investment from ‘ Information transfer, software and information technology services ’. For each infrastructure category, we disaggregate its investment into three assets (see section Disaggregating capital investment by asset type). Asset-specific investment data will be allocated to capital producing sectors according to sectoral shares in GFCF, obtaining a GFCF matrix that represents GFCF of capital producing sectors to build the infrastructure. Furthermore, we scale the GFCF matrix of infrastructure according to annual shares of infrastructure investment in total investment from associated investing sectors. Based on the scaled GFCF matrix, we further adjust GFCF of infrastructure producing sectors under the BAU scenario (if there is any investment default) to get Y GFCF under the KES scenario. Final consumption from seven infrastructure-related sectors will change proportionally according to their investment. We assume more investment in specific infrastructure will lead to more consumption (evidence to support this assumption can be found in Fig. S 7 ). Value-added in this scenario would change due to changes in final demand, compared with the BAU scenario. Intermediate inputs would also change to meet economic production of final demand and exports. The adjusted MRIO tables are balanced again using GRAS method. Direct CO 2 emissions from sectors are changed as well. It is assumed that the changed intermediate inputs in sectors compared with those in the BAU scenario changes emissions accordingly.

The KLC scenario is designed to focus on China’s future capital investment in low-carbon technologies by the electricity generation sector, and end-use sectors such as transportation services. Detailed data (Table S 8 ) for energy supply and energy use by energy sources (i.e., coal, oil, natural gas, nuclear and renewable energy), capital investment requirements on low-carbon technologies (e.g., carbon capture and storage, or electric vehicles) by different using sectors (e.g., industry sectors, or transportation services), CO 2 emissions by economic sectors are collected from the World Energy Outlook 2017 48 . The procedures to construct Y GFCF matrix under the KLC scenario according to the capital investment in low-carbon technologies and further adjustments on Y FC matrix are described in the development of the KES scenario. Changes in energy mix in the MRIO tables follows Fig. S 6 , which has been described in the development of the BAU scenario. International export would decline whereas international import would increase 51 , since the objective of this capital investment pathway is to reduce China’s territorial CO 2 emissions. The adjusted MRIO tables are balanced again using GRAS method. Lastly, we further adjust the direct CO 2 emissions from sectors accordingly, based on emissions data from the World Energy Outlook. Only relative changes in key parameters such as CO 2 intensity per unit of GDP are used in developing the KLC scenario.

Limitation and future work

This study has several limitations. Our model relies on data from multiple sources with different levels of uncertainty, such that the calculated results need to be interpreted with caution. For instance, it is more reasonable to identify temporal changes of capital-associated CO 2 emissions, relative importance of final consumption categories, or differences in results produced by different models. Second, evaluating the use of physical capital assets in production by capital consumption or capital services is highly debated. Data on capital consumption are more readily available than that of capital services. In addition, capital services rely on the prices of capital assets which have higher uncertainty among provinces and for different years. Capital consumption data are frequently calculated using the PIM, which has been widely accepted by national and international statistical agencies and researchers. Thus, we also conduct this analysis by relying on capital consumption to represent the use of physical capital assets. The limited number of categories of capital assets also raise uncertainty in asset-specific depreciation and emission properties. Miller et al. 52 showed that using detailed capital assets versus aggregated KLEMS assets leads to very different capital-input coefficients. This limitation is in line with a main limitation of IO modelling to aggregate products with different environmental properties into homogeneous sectors. This limitation hence states the importance to build such a capital database with a high resolution of types of capital asset and investing sectors. Another way to construct capital inputs in economic production is based on good life cycle inventory (LCI) databases which record inputs of key capital assets such as infrastructure, machinery, ICT, and etc 53 . One may argue that only lifespan-average capital inputs are recorded in most life cycle assessment. In this case, applying a proper approach in quantifying capital depreciation time series (e.g., the PIM) is a requirement in developing LCI databases. Third, when we develop capital investment scenarios, final consumption of capital investing and using sectors are further adjusted by their contributions in capital investment. A linear correlation is applied between sectors’ capital investment and final consumption, based on the correlations observed from electricity and water supply sector, and transportation services sector (Fig. S 7 ). Feedback of investments and side effects on consumption in other sectors are also neglected. This drawback arises from the static feature of the MRIO model. Integrated with a dynamic economic model, to some extent, can reduce the uncertainty from dynamic changes in capital investment and final consumption among all the economic sectors. Lastly, shifting the fossil-based economy to a renewable energy-based economy and achieving carbon peak and neutrality will request large capital investments in low-carbon equipment and infrastructure. Other alternative pathways of capital development are also interesting for future exploration, yet need other methods and approaches to model the entire economic and energy structures for future capital development narratives.

Data availability

The capital investment ( I ) data generated in this study have been deposited in the public repository Figshare with the identifier https://doi.org/10.6084/m9.figshare.20407572 54 .

Code availability

The source codes for data processing and capital-endogenization model are available at https://github.com/yequanliang1993/capital-endogenized-input-output-model .

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Acknowledgements

The time and comments from A. E. Steenge are gratefully acknowledged. Q.Y. is grateful for the scholarship he received from the China Scholarship Council (CSC), No. 201806710143. The time and comments from the editor and three referees are gratefully acknowledged.

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Quanliang Ye & Klaus Hubacek

Department of Planning, Aalborg University, 9000, Aalborg, Denmark

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Q.Y., M.S.K, Y.S. and K.H. designed the research. Q.Y. developed the model; Q.Y., M.S.K., Y.S., and K.H. analyzed the data. Q.Y., M.S.K., J.F.S, and M.B. discussed the results and designed the figures. Q.Y., M.S.K, Y.S., J.F.S, M.B., and K.H. wrote and revised the main manuscript.

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Ye, Q., Krol, M.S., Shan, Y. et al. Allocating capital-associated CO 2 emissions along the full lifespan of capital investments helps diffuse emission responsibility. Nat Commun 14 , 2727 (2023). https://doi.org/10.1038/s41467-023-38358-z

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NYC’s New Commercial Real Estate Owners: Private Equity and Building Users

'nobody ever wrote a book called "pendulums that swung just right."', by abigail nehring november 6, 2023 11:00 am.

When Doron Greenberg and Aviad Ohayon decided to leave the private equity world where they had apprenticed for about five years and start their own real estate firm, many New York landlords were licking fresh wounds.

It was 2019, and the state had just passed a landmark piece of legislation for rent-stabilized apartments that made it all but impossible for owners to raise rents and break free of regulation even after carrying out major capital improvements in their buildings. So owners who acquired properties just a year before suddenly found their business model obsolete.

But, to Greenberg, the situation presented an opportunity, which only ripened further when the pandemic hit six months later, triggering a mass exodus from Manhattan, historic inflation, and the rapid ascent of interest rates, beginning in the middle of last year.

“People can’t finance, can’t refinance, banks are sitting on the sidelines,” Greenberg said. “With all the difficulties we said, ‘OK, New York now presents a very unique opportunity because the price per square foot — the cost of bricks — is very low historically.’ ” With the right equity structure and a long-term investment horizon, Greenberg and Ohayon believed they could capture a slice of the city’s multifamily market.

Fast forward to October 2023. Their firm, GO-RE Partners, has just closed on its fifth deal in New York City, picking up a 77-unit, mixed-income multifamily building at 69 East 125th Street in East Harlem from Greystone Development for $28.2 million.  

The new development was completed in 2017 and will receive a 421a tax abatement until 2043, but Greystone was facing a deadline on its loan, according to sources with knowledge of the deal. The developer did not respond to a request for comment.

“For their own reasons, they decided it’s better to sell,” Greenberg said. “And we got a very attractive price per square foot for a new product. We can’t build this building today for the price that we paid for it.”

To Ariel Property Advisors’ Shimon Shkury, who was part of the team that brokered the deal at 69 East 125th Street, GO-RE Partners epitomizes a certain kind of owner in the new epoch: private, opportunistic buyers with a lot of equity to deploy and a long-term investment strategy.  

The city’s rent-stabilized building stock once had a very similar pool of investors as the unregulated market, Shkury said. “Today it’s only private capital,” Shkury said. “Those who invest in rent-stabilized today are private people, some syndications, who have one thing in common and that’s a long-term view, meaning they invest not for two years or five years but at least seven to 10 years, if not longer.”

The market for multifamily properties with income restrictions has similarly shifted in favor of private family offices and mission-driven capital, with Nuveen capturing headlines in May this year when it scooped up a massive affordable housing portfolio comprising some 12,000 units from Mo Vaughn’s Omni Holding Company.  

Nuveen — whose mission-driven capital is part of its larger $156 billion of assets under management — declined to disclose the sale price, but said the deal was part of $3 billion of acquisitions in its pipeline this year, Commercial Observer reported .

Anyone with good credit has a major advantage right now, and it will remain so as long as “the cost of capital is the highest it’s ever been in memory,” said Eastdil Secured’s Will Silverman.

In Silverman’s world of Manhattan trophy properties — where Eastdil brokered more than $1 billion in sales last year — everybody wants to sell.  

“Users can usually pay a premium because there’s no developer profit,” Silverman said. “The challenge is often they’re not able to accommodate the timetable of a New York City deal. So you’re talking about maybe getting a higher price for people that are capricious and slow-moving.”

Vanbarton Group’s sale of 15 Laight Street to Korean automaker Hyundai in February of this year for $273.5 million is Exhibit A. Hyundai paid all cash for the boutique eight-story office tower in Tribeca, Bloomberg reported . It plans to use all 108,000 square feet of floor area for offices and showroom space.

Six months later, vacuum kingpin James Dyson sunk $135 million into acquiring 747 Madison Avenue from billionaires Jeff Sutton and David and Simon Reuben, each of whom shared a stake in the 17-floor retail co-op through their private equity firms, Wharton Properties and Reuben Brothers.

The U.K.-based Dyson family office, known as Weybourne Holdings, began its foray into the New York market in March, when it bought 155 Mercer Street for $60 million, public records show. That’s a deep discount from seven years ago, when the three-story SoHo building last traded for $93 million.

There’s no consensus right now on what the future holds for the city’s office market, Silverman said, but there have been a few non-users making purchases. Notable ones include the Japanese developer Mori Trust picking up a 49.9 percent stake in 245 Park Avenue from SL Green Realty in June at a $2 billion valuation .

“Most of the non-user buyers are private family investors taking the view that it’s Manhattan, it’s well-located, I’m going to buy,” Silverman said. “Nobody ever wrote a book called ‘Pendulums That Swung Just Right.’”

Silverman is of the mind that the pendulum has probably swung too far at this point. He warned against relying too heavily on the oft-cited return-to-office figures put out by security firm Kastle Systems, which uses key fob data to create a barometer of office occupancy across U.S. states.

The problem is that large landlords like Vornado Realty Trust and Boston Properties do not use Kastle’s access control products, leaving a significant gap in the data.

New York City investment sales volume dropped 31 percent annually in the first half of 2023, according to an Ariel Properties Advisors report .   The slump in sales velocity could very well signal the start of a downturn in commercial real estate, but as for new entrants to the market, Meridian Capital Group’s David Schechtman said there simply isn’t enough activity to focus on a heavy trend.

He said Meridian has 11 deals slated to close before the end of the year, some of which will involve out-of-town capital, others to previously unknown buyers.

“I wouldn’t say it’s as linear as years past where you say China is hot, and it’s tied to global economic forces,” Schechtman said.  

He said he’s seen investment flowing into New York City this year from Chicago, Toronto, Montreal, South Korea and South America — to name a few — but Schechtman declined to get into specifics, noting only that some of the newcomers had a modicum of success previously, but are now finding their equity will go further in New York City and the barriers to entry are lower.

“There are a lot of people who want to transact this year or next with the belief that we’re just two years away from interest rates dropping,” Schechtman said.  

Then again: “You can never time a sale perfectly.”

Abigail Nehring can be reached at [email protected] .

WeWork Files for Bankruptcy

Wework stock trading halted amid bankruptcy rumors, report: record multifamily deliveries constricting rent growth, commercial real estate turnover: why pros leave — and what comes next.

By Nicholas Rizzi

By Abigail Nehring

By Brian Pascus

Local News Matters

AC Transit invites public feedback on three proposals for realigned East Bay bus routes

Posted: November 6, 2023 | Last updated: November 6, 2023

The Alameda-Contra Costa Transit agency is asking for the public’s input on three possible system-wide bus service redesigns.

Earlier this year, agency officials asked people to weigh in on the “ AC Transit Realign ” project and then, based on that feedback, established equity, reliability and frequency as the guiding principles for the redesign phase.

During this phase, people are once again asked for their comments, but this time on the three specific “preliminary service scenarios,” each of which feature different bus route and schedule changes throughout the system.

The first proposal is called “ Balanced Coverage ” and leaves the current system pretty much the same, although it includes strategies to increase ridership, according to AC Transit officials.

In the second option, “ Frequent Service ,” the system would reduce or end bus service in areas with the lowest ridership and reallocate “resources to areas of high demand.”

“A third scenario called the ‘ Unconstrained Vision ’ represents an aspirational proposal, which envisions the bus network’s operation supported by new sources of significant funding,” the agency said in a news release Thursday.

To weigh in on the plans , people can visit AC Transit Realign landing page.

AC Transit runs 151 bus lines that serve 13 cities and unincorporated communities in Alameda and Contra Costa counties.

The post AC Transit invites public feedback on three proposals for realigned East Bay bus routes appeared first on Local News Matters .

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