How much of your global stock allocation should be in the United States?

The risk-free rate is simply the return of Treasury bills. A higher Sharpe ratio is better, and a good rule of thumb is that risky asset classes have Sharpe ratios that cluster around the 0.20 to 0.30 range.

The 60/40 allocation only spends about 22% of the time at new highs, and the other 78% in some degree of drawdown. Drawdowns are physically painful, and the behavioral research demonstrates that people hate losing money much more than the joy of similar gains. To be a good (read: patient) investor you need to be able to sit through the dry spells.

Currently, your ten-year nominal return for buying U.S. government bonds will be around 2.25% if held to maturity.

The Sharpe ratio is a measure of risk adjusted returns, and is calculated as: (returns – risk free rate)/volatility.

Once CAPE ratios rise above 30, forecasted future median real returns are negative for the following ten years – it doesn’t make sense to overpay for stocks!

Quick, what is the world’s largest financial asset class? Don’t know? Answer: Foreign ex-U.S. bonds!

The most venerable asset allocation model is the traditional 60/40 portfolio. The portfolio simply invests 60% in stocks (S&P 500) and 40% in 10-year U.S. government bonds.

The reason many people will invest in both stocks and bonds is that they are often non-correlated, meaning, stocks often zig while bonds zag.