The 60/40 Portfolio, Destroying Old Myths and Exploring New Opportunities
35 years ago, investing seemed simpler. The standard pension portfolio was 60% in stocks and 40% in bonds. Stock picking was a key differentiator, as mutual funds, Exchange Traded Funds, and alternative investments were just coming into more common use. Bonds were at the inception of the 40-year decline in interest rates, which was a constant prop to positive bond prices. Economic soft patches, recessions, stagflation and bear markets did interrupt the progress on occasion, but over the long-time horizons pension plans invest for, the 60/40 portfolio was portrayed as the easy solution for a successful outcome.
But, let’s examine the reality, especially in light of the current stock market, economic and interest rate environment we now operate in. Depending on your risk tolerance and goals, 60/40 portfolios, while under some market and interest rate environments can be effective, are just not the lock on success they were portrayed to be. As we have discussed in previous newsletters, humans are subject to biases and heuristics and the desire to find short-cuts and simplifications to make complicated or difficult topics understandable. But, alas, the 60/40 portfolio over-simplified an attempt to make an all-weather portfolio, when the reality is, the Tech Wreck of 2000, the Great Recession of 2008 and the COVID Crash of 2020 have demonstrated a traditional 60/40 portfolio cannot weather all storms.
Examining S&P 500 10-year rolling returns for the 20-year period ending 3/31/19, shows the following results:
The median return was 6.3%
The returns ranged from 16.8% to -5.1%
One-quarter of the time, the return was below 3%
About 10% of the time, the return was negative
If we marry the 40% bond allocation (US Investment Grade bonds that are currently yielding less than 2.25%), with the median stock market return of 6.3%, the blended return is only 4.28%...most likely insufficient to meet most investors needs and goals. And with interest rates at historic lows, when interest rates begin to rise, the 60/40 portfolio will be at risk of the loss of principal as the bond values go down in their inverse relationship with interest rates.
The new opportunity? Fixed and indexed annuities*do not have the downside market risk shared by the stock and bond markets. In the indexed annuity, your original principal investment, held for the annuity contract period, is your minimum return. Indexed annuities have downside protection and participate in the upside of any number of equity and multi-asset class indexes. The fixed annuities pay a stated return for a period certain and provide your minimum return as your principal plus the stated return. Substituting an annuity for the bond allocation in a portfolio can provide a potential source of returns without downside market risk, and potential returns superior to current bond yields. Voila! The new 60/40 portfolio…60% of the portfolio in the stock market for long term growth, and 40% of your portfolio buffered from downside risk in any of a number of fixed or indexed annuities. Make an appointment today to see the universe of managers we have to custom build your 60/40 portfolio. See the hyperlink below to view our whiteboard presentation on annuities and other investment and retirement topics.
*Annuity returns and guarantees are subject to the credit worthiness of the issuing insurance company.
Respectfully, Dave & Drew