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Not Your Father’s 60/40

Research Affiliates has a good piece out that touches on the future difficulty of owning a 60/40 stock/bond portfolio. They predict that a 60/40 will generate a measly 1.2% in real terms going forward.  I am less pessimistic, however, I do think that a 60/40 will fail to generate the types of returns that investors have come to expect.

The November Orcam report touched on the problem of bonds in a portfolio and how a balanced portfolio was likely to disappoint investors going forward. The general idea is rather simple – if a 60/40 stock/bond portfolio generated a 9% annual return over the last 50 years then what should we expect a 60/40 to achieve in a low interest rate environment?  Well, the math is relatively simple.  If an aggregate bond portfolio generated a 7% return over this period then it’s virtually impossible for a 60/40 to generate the same types of returns in the future that it has in the past. With a 30 year T-Bond yielding just 2.4% the math doesn’t work.  And if stocks somehow make up the difference then you’re achieving the same return for more risk (because the stock component is inherently riskier).

This creates quite a problem for investors.  I’ve referred to the 60/40 as one of the latest and greatest performance chasing fads. In essence, investors piling into this strategy are chasing a massive bull market without realizing that this portfolio’s performance is largely due to the incredible performance of bonds.  I’ve estimated that a 60/40 is likely to generate returns of about 5.5% (about 3.5% real).  And interestingly, we’ve already started to see the 60/40’s performance degrade from an average of 9% growth over the last 50 years to just 7.1% over the last 10 years. And if I am right then that figure is likely to drop on average going forward. God forbid stocks stop averaging their 5 year annualized growth rate of  15% (a near certainty).

Today’s 60/40 ain’t your father’s 60/40. And that means investors who are looking for the same risk adjusted return from the 60/40 of old will be forced to find alternative ways to achieve that.