The 60/40 portfolio allocation keeps burning investors, so why do they still use it?
The stock-market rollercoaster ride is enough to get any investor a little nervous. Yet, so far swings in the Dow Jones Industrial Average’s and S&P 500 are still only a tremor on any longer-term view. Stock prices are higher than they were even one year ago. Nonetheless, for many investors, it’s an overdue reminder that stock prices can fall — and fall a long way — as well as rise.
That makes it a good moment, say, experts, to take stock of your portfolio. Are you taking on more risk than you want? Worse, are you taking on more than you realize? You may well be. And your financial adviser, if you have one, may not realize it either.
Conventional wisdom says that a “balanced” portfolio of stocks and bonds will cushion you from shocks and make sure your savings keep growing in all markets. It’s the philosophy behind nearly all financial advice offered in America today, and one that’s taught in most finance courses.
It’s also the theory behind those “balanced” index funds, “target date” funds and “glide path” funds that try to offer you a one-stop portfolio. It’s also the theory behind the portfolios offered by most “robo advisers.”
There’s just one problem: History says it may be wrong.
A “balanced” portfolio of stocks and bonds failed previous generations of U.S. savers, and badly, during at least two extended periods during the past century alone, financial historians note.
Worse, those occasions had more than a passing resemblance to the situation today: Expensive stocks, expensive bonds, and concerns about rising interest rates and rising inflation.
Why some people have déjà vu
Here are the numbers. For an entire decade, from 1938 to 1948, a portfolio of 60% U.S. stocks and 40% U.S. Treasury bonds actually went backward in relation to inflation. That’s based on data compiled by New York University’s Stern School of Business, as well as inflation data tracked by the U.S. Department of Labor.
Over that period, not only did savers not get rewarded for investing, they got penalized. Their portfolios lost purchasing power. Furthermore, that’s before taxes. If inflation is 5% and your portfolio rises 5%, you earned a zero “real” return but you are getting taxed as if you earned 5%.