A recent equities.com article titled “Feeling Fifty-Fifty About the 60-40 Portfolio” declared that the 60-40 stock-bond allocation formula caused losses in 2022 and threatened the same in 2023.
Many market participants are abandoning the old rule of thumb, and that trend looks set to continue. My response? Why did it take this long for market participants to abandon this outdated portfolio allocation? The answer probably lies with the old-guard Wall Street financial planners and advisors who steer their clients toward this allocation.
Why does Wall Street steer its clients towards the 60-40 allocation? Because it’s simple and lucrative – 60% in stocks and 40% in bonds. What could be easier? Advisors can put their clients’ portfolios on autopilot and make money on autopilot. And with commissions tied to stock and bond transactions, the churning of portfolios – as long as the 60-40 allocation is kept, makes for money-making at its easiest.
Wall Street loves the 60-40 allocation, but it doesn’t work. It worked at one time, but it hasn’t worked for decades. The classic 60-40 portfolio allocation strategy is outdated. The 40-year-old 60-40 rule was created when bond yields averaged 8%, and stock market returns averaged 12% annually. But with the average return of a 10-year treasury at 0.62% spglobal.com, this strategy no longer makes sense.
There was some logical basis to the 60-40 strategy. It hasn’t always been bad. Back when it worked in the 80s, the thinking was that bonds provided a hedge against a stock market crash where if stock prices fell, bond prices would rise to compensate for losses. It made sense when it averaged more than 10%, but that is no longer the case, and bonds are no longer an effective hedge against a stock dive.
The 60-40 strategy is particularly a bad idea when instead of moving in the opposite direction of a stock crash, bond prices move in the same direction. This happened in early 2018. In February 2018, the S&P 500 fell slightly more than 10% from its highs set on January 26th, while bonds sold off. Without its downturn-hedging benefits, bonds are pretty much useless in today’s low-yield environment, and the 60-40 strategy is a bad idea.
The 60-40 strategy doesn’t work, and the fact that so many investors adhere to it is alarming. Most who cling to this strategy will not be prepared for retirement. The proof is that “80% of U.S. pre-retiree households are financially unprepared for a secure retirement.”
If you want to be prepared for retirement:
- Ignore the 60-40 portfolio allocation and anything else Wall Street tells you to do to prepare for retirement.
- Don’t follow Wall Street.
- Follow those who have already retired early for how you should allocate your portfolio.
The 60-40 allocation was intended to generate consistent recession-resistant returns. Although the 60-40 allocation is no longer effective in accomplishing this goal, you might consider another allocation strategy – one that has worked for ultra-wealthy investors for decades.
For investors seeking the benefits that the 60-40 allocation provided 40 years ago, including high annual returns and a hedge against downturns, consider an allocation strategy weighted heavily towards alternative investments – particularly productive tangible assets that cash flow and appreciate.
The late David Swensen, a prominent endowment fund manager, was a leading cheerleader for alternative assets. Swenson took over as the Chief Investment Officer of the Yale Endowment in 1985. When he took over, endowment assets were allocated almost entirely to stocks and bonds, making up more than 80% of the Yale portfolio.
However, under Swensen’s direction, the Yale Endowment moved away from stocks and bonds to one allocated heavily towards alternative investments, with less than 20% invested in public equities. The result? The Yale Endowment has seen an average annual return of 11.3% over the past 20 years. The S&P averaged an annual return of 7.3% during this time.
The wealthy have long allocated to private alternative investments like commercial real estate and income-producing private businesses to generate above-average income insulated from volatility. It accomplishes what the 60-40 allocation was originally designed to accomplish.
All signs are pointing to a recession in the near future, and a 60-40 allocation will not save you. It may aggravate losses.
To hedge against a recession, allocate to private alternatives that are insulated from broader market volatility and that can provide cash flow that compensates for lost wages or jobs.
Kyle Jones is a co-founder and Key Principal of TruePoint Capital, LLC. Kyle is responsible for the company’s strategic planning, investment decisions, asset management, and overseeing all aspects of the company’s financial activities, operations, and investor relations.
Kyle obtained a Bachelor of Science degree from Texas State University – San Marcos, where he also played Division 1 Baseball.
