PROGRAM NOTE: This is our 50th edition of Considerations! Still here. No ads, pop-ups, click-bait, crude language, conspiracy theories. Never will be. Thank you for reading.
The financial industry thrives on hype, promise, pie-in-the-sky, exaggeration, only to be followed by customer disappointment and regret. Crypto is a classic current example. Notice where you see too-good-to-be-true and be skeptical.
This works in reverse too. The industry decides to get on a band wagon about not liking something, and the pendulum swings to the other extreme. The 60/40 portfolio is a classic current example. Have things gotten too-awful-to-be-true? Let’s take a look.
First, what’s a 60/40 portfolio? It’s a portfolio where 60% of the holdings are stocks and 40% are bonds.
In the 1950’s, Harry Markowtiz developed what came to be known as modern portfolio theory (MPT). He was awarded a Nobel Prize for it in 1990. The theory describes optimum portfolio risk and return relationships. In practice, one application has been the creation of the 60/40 portfolio strategy that is now widely used in institutional and retail accounts.
If you’re reading this, you probably have something close to a 60/40 portfolio (+/-10%). That’s a good thing. So, what’s all this talk about the “death of 60/40?”
It’s emerged because the 40-part, the bonds, are not delivering their historic returns. Historically, bonds have returned about 6%. But we haven’t seen 6% for over 20 years! In fact, in 2020, rates fell below 1%!
This explains why a 60/40 portfolio has only been delivering returns in the 6% range for several years now. Conditions have become even more difficult with the recent rise in interest rates and subsequent decline in bond prices. A perfect storm for balanced portfolios. Hence, the death of 60/40.
Now, here’s the good news: There have been prior “deaths of 60/40” and we're still here. There have been six of them since 1962. In four of those six cases, portfolio returns in the following five years were in double-digits and far outran whatever inflation was in the period. The other two were respectable enough to offset inflation.
What are the takeaways here?
First, know that information is often transformed into misinformation by those with a particular agenda or incentives. As Charlie Munger says, “Never, ever, think about something else when you should be thinking about the power of incentives.” Some people can be paid enough to ignore the truth. And sadly, some customers are willing to be lied to.
Next, periods of under-performance are reliable harbingers of periods of out-performance, and vice-versa. Mean reversion is one of the most powerful forces of investing. Knowing this can be a huge advantage. Past performance does suggest future performance in a perverse, counter-intuitive way.
And last, it can be confusing to pick your way through this stuff. So, opinions and guidance that’s free from external pressure or incentives is most desirable. That’s why we’re here. Our incentives are to be on the mark so you can move toward your goals and come back to us again. No one else is paying us and we like to be liked.
James Cosgrove, CFP, Plano, TX jim.cosgrove@verizon.net 972-489-0262
Jim Cosgrove, Partner, San Jose, CA jimcos42@gmail.com 408-674-6315 Twitter@JimCos542
Evidence-based. Rules-driven. Policy-focused.
