|
|
|
|
|
The Muscular Portfolios Newsletter — No. 57 — Nov. 30, 2023
|
|
|
Get our FREE newsletter emailed directly to you
 We’ll immediately send out your very own subscription to our newsletter. Learn to grow your savings faster than the market without those awful crashes! It’s easy to subscribe — and you’ll also receive our money report free of charge. Use this link to get the newsletter or visit:
https://MuscularPortfolios.com/1
|
|
The 60/40 portfolio is debunked
 By Brian Livingston
Individual investors have been told for decades, “You should allocate your life savings 60% to stocks and 40% to bonds.”
Supposedly, the prices of bond funds go up when stock funds are crashing. Pundits have repeatedly claimed that a rather large allocation of 40% to bond funds would cushion investors against losses during bear markets in stocks.
If that actually worked, it would be great. Stock investors are subjected to heart-wrenching collapses more often than people generally realize. On average since 1945, a bear market — an S&P 500 price drop of 20% or more — has hit US investors about once every five years. (See a Hartford Funds analysis.)
The 60/40 strategy is often promoted as “a balanced portfolio” or “the pension model.” The latter term arose because a 60/40 allocation was generally followed by giant financial institutions, such as university endowments and state retirement funds. For example, the $40 billion Yale Endowment Fund as recently as 1990 allocated 85% of its capital to a traditional stock/bond mix.
But such institutions years ago abandoned stocks and bonds as their primary investments. Why? In the decade 2000–2009, the annualized return of a US-based 60/40 portfolio (adjusted for inflation) was minus 0.3%. Negative real returns like that aren’t going to fund many retirements for employees or expenses for universities! (See Figure 1.)
|
|
|
Figure 1. The 60/40 portfolio punished investors with a negative return during the 10 years ending in 2009. (Notice the three red bars in 2001, 2002, and 2008.) In 2022, the model lost 17% — its worst single-year drop in nine decades. Source: The Leuthold Group via WSJ article
|
|
Large financial institutions have largely abandoned the 60/40 model. As of 2022, the top five North American pension funds and endowments, on average, assigned less than one-third of their capital to common stocks and bonds.
For instance, the endowment funds of Yale and Harvard both allocated only 26% to public equity and fixed-income (including cash) in 2022.
|
|
Instead of stocks and bonds, the five leading pension funds and endowments now invest the majority of their money in:
- Hard assets, such as real estate, commodities, and so forth;
- Alternatives, such as private equity and hedge funds, which most individuals cannot buy into.
What a switch! Even pension funds don’t follow the pension model anymore. (For details, see an Auspice Capital article.)
|
|
Pundits are changing their tunes about 60/40
Too many individual investors mistakenly assumed that a “balanced” 60/40 portfolio would protect them from losses during falling equity markets.
The opposite is actually true. Owners of bond funds can lose a great deal of money during periods of rising interest rates or high inflation. The years 2022 and 2023 proved this the hard way to buy-and-hold investors.
In just nine months — Jan. 3 through Sept. 30, 2022 — the S&P 500, represented by the SPY index fund, fell almost 25% in a shockingly sudden bear market. See Newsletter #56 for a graph.
Meanwhile, Vanguard’s exchange-traded fund that tracks long-term Treasury bonds, EDV, did even worse. From the same starting date of Jan. 3, 2022, through Oct. 19, 2023, the bond fund lost 51% of its owners’ money. The fact that this grinding loss unfolded over a 22-month period did nothing to ease bond investors’ pain. See Figure 2.
(Note: The Papa Bear Portfolio includes EDV as one of the 13 global asset classes it can tilt into. But the Papa Bear hasn’t recommended holding EDV since August 2020.)
|
|
|
Figure 2. The S&P 500 index fund, SPY (including dividends), fell nearly 25% during the 2022 bear market. Vanguard’s long-term Treasury bond fund, EDV, lost 51% of buy-and-hold investors’ money from Jan. 3, 2022, to Oct. 19, 2023. Source: StockCharts
|
|
The “balanced” strategy’s problems gained wide public notice last month when financial analysts started loudly complaining. The commentators wrote that the traditional pension model, although not quite dead, is not appropriate for most investors.
One of these analysts is Spencer Jakab, the editor of The Wall Street Journal’s popular “Heard on the Street” feature. He posted on the WSJ website last month a dramatic warning titled “Your ‘Set It and Forget It’ 401(k) Made You Rich. No More.” The next day, his dire online forecast was prominently positioned on the front page of the newspaper’s Oct. 26, 2023, business section. Here are some excerpts:
“Stock-and-bond portfolios that worked for the past 40 years aren’t ready for what’s coming.
“Last year was one of the worst ever in real terms for a 60/40 portfolio, and the beatings could continue.
“Bonds, the yin to stocks’ yang in a balanced portfolio, are the real wild card. ... One unnerving possibility is that the Fed could reverse course and push rates down again if today’s high rates cause a recession or a stock-market meltdown. That could stoke 1970s-style inflation, or worse.
“Ironically, the traditionally risky part of the 60/40 portfolio could be safer, relatively speaking. Stocks cratered in the inflationary 1970s, but they are more resilient to inflation than bonds.”
A wave of other writers jumped onto this theme. Hopefully, the 60/40 portfolio will never be looked upon favorably again.
|
|
|
Bonds, too, can lose money when stocks are crashing
|
|
|
In an article titled “The Trusted 60-40 Investing Strategy Just Had Its Worst Year in Generations,” WSJ reporter Eric Wallerstein lays out the problem in stark terms:
“Wall Street’s boilerplate mix of stocks and bonds isn’t cutting it.
“For generations, financial advisers touted the 60-40 strategy as the single best way for ordinary people to invest. The idea is simple: owning stocks in good times helps grow your wealth. When stocks have a bad year, bonds typically perform better, cushioning the blow.
“Not anymore.”
Wallerstein points out that the price of bonds used to be uncorrelated with stocks. In other words, if stocks crashed, it was possible for bond prices to rise. But bonds are now highly correlated to stocks.
In a graph like the one in Figure 3, he shows that long-term Treasury bonds are now more correlated with the S&P 500 than at any other time in the last two decades.
|
|
|
Figure 3. The yellow line shows that the US inflation rate rose from 0% to more than 8% between May 2020 and March 2022. In the same period, bond correlation with stocks rose from 0.00 (uncorrelated) to over 0.50 (highly correlated). Bonds are now likely to fall when stocks do. Source: Kohlberg Kravis Robert & Co. article
|
|
Even worse, bonds don’t deserve their reputation as a stable store of money. As Wallerstein points out, “Investors lost money holding bonds when accounting for inflation” in the long four-decade period from 1945 to the 1980s.
More recently, holders of long-term Treasurys have lost half of their money since 2019. Bond holders who bought $100 worth of bonds in 1945 had a gain of 500% by 2019. (In other words, their holdings had a value of $600.) As of last month, Treasurys had fallen to only a 200% gain. (That’s equal to just $300.)
These numbers are illustrated in Figure 4, which is based on Wallerstein’s reporting.
|
|
|
Figure 4. Investors in long-term US Treasury bonds lost money for four decades, from 1945 to the mid-1980s. Since 2019, buy-and-holders have seen their $600 (a gain of 500%) shrink to only $300 (an overall gain of just 200% in 78 years). Source: Standpoint Asset Management via WSJ article
|
|
|
Target-date funds are a minor variation of 60/40
|
|
Articles such as the ones mentioned above all had a similar omission: They failed to tell individual savers which investing formula would work for them.
One exception was a piece titled “Why the 60/40 portfolios might be dead, and what to do now.” Like other writers, retirement reporter Alessandra Malito echoed Jakab’s warning and linked to it. In a MarketWatch article, she then made an actual proposal: target-date funds might overcome the weakness of the 60/40 model:
“Many retirement savers use a target-date fund, which is linked to a retirement year such as 2050 or 2055. The portfolio automatically shifts asset allocations from risky to conservative the closer it gets to that ‘target’ year.
“Even this strategy could be too basic for some investors’ retirement needs, so it’s still important to consult with a financial professional or run the numbers thoroughly to ensure it meets goals.”
“Too basic” doesn’t even begin to cover it. Target-date funds are highly volatile. For example, the Vanguard Target Retirement 2065 Fund opened its doors in 2017. It started with a hugely risky 90% allocation to stocks. It devoted only 10% to bonds.
|
|
Across the entire industry, the average target-date fund that matured in 2010 crashed 30% in a single year: 2008. The worst fund fell 41%. Those losses are far worse than investors should tolerate. Target-date funds are a formula for disaster. (For more information, see a WSJ article and Figure 20-4 of the book Muscular Portfolios.)
Considering the number of times I’ve said investors must look only to the long term, you might be surprised by all the attention that’s being paid in the media to a single-year loss in 60/40 portfolios.
If average savers are freaked out by a one-year loss, they’ll really have heart attacks when stocks and bonds seriously crash simultaneously. The year 2022 wasn’t nearly as bad as things will get one of these days.
Mark Hulbert, a MarketWatch columnist, expressed this well when he provided Malito with the following quote for her article:
“There have been many times in history when the 60/40 portfolio has had five- and 10-year returns that are a lot worse than what we’re seeing now.”
(Disclosure: I was contracted by MarketWatch to write a series of investing columns in 2018 and 2019. MarketWatch is a subsidiary of Dow Jones & Co., which also owns WSJ.)
|
|
|
We’re in a new era — bonds alone provide no safety
|
|
We now find ourselves in a period of high interest rates and higher-than-usual inflation. How long this will last — and whether it’ll be the “new normal” for the foreseeable future — is unknowable.
A valuable assessment of buy-and-hold investors’ dilemma is provided by financial writer Jason Milton. He cites statistics that show how the year 2022 reflects a major shift:
- For the first time ever, Treasury bonds performed worse than US stocks in a major drawdown.
- In 2022, the S&P 500 lost 19%, but the 20-year Treasury bond crashed 31%.
- US stocks fell in the greatest number of weeks since 1931, and Treasurys fell in the greatest number of weeks in history.
Milton is a subscriber to the Muscular Portfolios Newsletter. He’s taught his four minor children — one of whom started at age 7 — to manage the Papa Bear Portfolio all by themselves in their own, separate brokerage accounts. (See Newsletter #55 for details.)
Milton’s full comments on the sea changes investors face in the market are available in a Medium article.
|
|
|
The winning formula is freely available, and you have it
|
|
Let’s conclude this discussion and sum all of it up with the following points:
- All static asset-allocation formulas badly underperform the S&P 500. For more than a decade, independent authorities such as MarketWatch and MyPlanIQ have tracked the performances of every possible variation of what’s called a “Lazy Portfolio.” Every unchanging asset allocation has horribly underperformed. The portfolios returned only 4.57% to 8.60% annualized, compared to the S&P 500’s 12.74% in 2013–2022. For details, see Figure 4 of Newsletter #50.
- Even worse, Lazy Portfolios crash almost as badly as the S&P 500. The static portfolios have lost 35.5% to 49.0% during bear markets. That’s unacceptably close to the 55.3% that the S&P 500 lost in the 2007–2009 financial crisis. And it’s far beyond the 20% to 25% tolerance that average investors have for losses in their life savings. See Figure 5 of Newsletter #50.
- Lazy Portfolio promoters assume that more risk equals more return. This is based on a very old economic paper published in 1964 by University of Washington associate professor Bill Sharpe. The theory was thoroughly debunked by numerous economists as early as 1972, just eight years later. But the advocates of static allocations cling to the fallacy. See Figure BC-5 of Muscular Portfolios.
- Nobel laureates have proved that momentum exists. University of Chicago finance professor Eugene Fama won the Nobel Prize in Economics in 2013 for his findings. He and his coauthor Kenneth French of Dartmouth wrote several peer-reviewed academic papers on market factors. Their studies concluded in 2007, 2011, and 2014 that “the premier anomaly is momentum,” “there is return momentum everywhere,” and “all models that do not include a momentum factor fare poorly.”
- Investors must tilt their portfolios as sailors tack their sails. A sailor who doesn’t know how to tack won’t get to the intended destination. In the same way, investors who don’t understand how to gradually tilt toward the strongest asset classes won’t build their wealth very fast.
- It’s easy to take advantage of a classic, timeless wisdom. “The trend is your friend, till the trend has its end” has been true ever since the Amsterdam Stock Exchange first opened in 1602. But wealth managers who are stuck in 1960s economic theories are still charging high fees to put investors into plans that never change and don’t work.
You’ve discovered Muscular Portfolios. Great! You can use the website of the same name to find each month’s strongest asset classes for free. It takes just 10 minutes to update your portfolio.
That’s the good news. It’s unlikely to win a Nobel Prize. But forget prizes! It’s better to know that your money will grow with no fear of crashes.
We’ll have occasional down years, of course. Every risk-based portfolio does. But we won’t suffer the stroke-inducing 30% to 50% crashes that the S&P 500 subjects investors to every 10 years, on average.
Enjoy having a free and fully disclosed “dynamic portfolio.” Forget about debunked ideas like the 60/40 portfolio, target-date funds, and static asset allocations.
|
|
|
Reader — Please share the tiny URL of this free article: BRI.LI/231130
|
|
News from the leading edge
|
|
Hello is in Windows 10 and 11, but passkeys are better
Microsoft added Hello PINs to Windows 10 back in July 2015. (Photo by Somphop Krittayaworagul.) But Redmond has now joined with other software giants — including Amazon, Google, Yahoo, Instacart, PayPal, Uber, and dozens more — to adopt “passkeys.” In a September 2023 update, MS added passkey support to Windows 11. The new method is more secure, faster, and easier to use than old-style passwords. It’s backed by the World Wide Web Consortium (W3C), the Internet’s main standards body since 1994. Using a passkey to sign in will soon touch every aspect of your computing life. AskWoody Newsletter
Get the Public Defender column
Brian Livingston reveals the secrets of the Web in his Public Defender column for the AskWoody Newsletter (formerly the Windows Secrets Newsletter). How to subscribe to the free newsletter
|
|
Get the book that frees you from Wall Street
Every investor needs a copy of Muscular Portfolios, which reveals the best investing strategies for 401(k)s, IRAs, and every other kind of savings plan — without your paying a penny to “financial advisers.”
Order the book from Amazon, Barnes & Noble, and many other booksellers.
“I know of no book for a general investment audience that is more thoroughly researched and backed up by hard data.”
—MARK HULBERT, founder of the Hulbert Financial Digest
|
|
|
|
|
|
|
Our mailing address is: