For almost half a century, Wall Street has been telling us a whopper.
Specifically, that a so-called “balanced” portfolio – 60% in stocks and 40% in bonds – is an ideal way to stay invested in the stock market while reducing risk. Especially if you’re a conservative investor or retiree.
Dozens of mutual funds exist to make such a simplistic approach even easier, too.
And sure enough, like lambs to the slaughter, countless Americans have plowed hundreds of millions of dollars into these funds.
Heck, check your 401(k) plan at work. I’ll bet you dollars to donuts that there’s a balanced fund option just waiting to seduce you with its promise of modest returns and lower risk.
Total hogwash. And in honor of Myth-Busting Mondays, I’m going to prove it with a single number… 99%.
That’s the correlation a traditional 60/40 allocation has with a portfolio that’s 100% stocks. In other words, a balanced portfolio moves in almost virtual lockstep with a pure stock portfolio.
So if you’re investing in a traditional balanced fund, you’re essentially investing 100% in stocks.
Shocked? You should be. Because this isn’t some market anomaly caused by the severity of the Great Recession and compounded by unprecedented low yields on bonds.
Nope. It’s been going on for the last 15 years, according to the number crunchers at BlackRock.
Of course, I never take any stat at face value on Wall Street. So I did some further digging and number crunching. What did I discover? Even more shocking news…
This near-perfect correlation has existed for over 40 years.
As Robert Arnott reveals in his “Bonds: Why Bother?” article in the Journal of Indexes, “One little-known fact is that the classic 60/40 balanced portfolio has roughly a 98 percent correlation with stocks [since 1969].”
And all the while, Wall Street has been peddling balanced allocations to us as a sound alternative to investing entirely in the stock market.
In fairness, a recent survey by Natixis Global Asset Management reveals that advisors are waking up to the error of their recommendations.
Approximately 40% of 163 advisors questioned believe a 60/40 allocation is no longer the “best way” to achieve performance and manage risk.
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But that’s an awfully small sample size.
Plus, the omission isn’t exactly a full-blown repentance. I mean, saying the traditional 60/40 allocation isn’t the best way to increase returns and manage risk is simply dodging the issue.
It’s a terrible way. Particularly now.
- A 60% allocation to U.S. equities ignores a world of diversification opportunities. In 1970, U.S. stocks represented 70% of investable market cap. Today, they represent less than 46%.
- Bonds perform worst in the current environment. Average annual returns for bonds during rising inflationary and rising growth periods clock in at just 1.1% and 3.9%, respectively. That compares to returns of 7.1% and 8.8% during periods of falling inflation and falling growth, respectively, according to Merrill Lynch’s Alex Shahidi.
So what’s an investor to do?
If you’re after a simplistic, do-it-yourself option, consider replacing the traditional 60/40 allocation with the alternative proposed by Shahidi in a paper for the Investment Management Consultants Association. That is, a portfolio of 20% stocks, 30% long-term Treasury bonds, 30% TIPs and 20% commodities.
Such a portfolio can easily be constructed with low-cost ETFs and/or mutual funds.
Or ignore brokers who regurgitate old-school advice that doesn’t work. Instead, find one who’s committed to taking the time to customize a strategy that suits your individual risk tolerance and time horizon.
It might take some time to find such an individual. But it’s worth the effort if you care about preserving and increasing your net worth.
Bottom line: The classic asset allocation – 60% equities and 40% bonds – is virtually no better than a 100% allocation to stocks. So know the risks and be wary of any broker who might be recommending such a strategy.
Ahead of the tape,