The Death of the 60/40 Portfolio?

A diversified bond portfolio and a diversified stock portfolio, they play really well together. I mean, it's a simple way to accomplish it, right? I mean, tequila, lime juice, and simple syrup play really well together, right? Like don't complicate it. I mean you want to think about it like that, right? There are these time tested things that can help you accomplish what you're trying to do. And I mean, do you really need to make it more complex? David Booth, our co-founder and chairman, I think he has a great line where he says, you know, usually complexity does not add value. And it kinda goes back to what you're saying there with your margarita. You got a great mix. Don't mess it up. Don't mess with it. I think it's too complex once you add the lime and the simple syrup, I guess in that scenario, I'm a hundred percent equity investor here. Welcome to "The Informed Investor" where we break down the latest financial headlines, bringing in Research and insights to help you separate the news from the noise. A portfolio of 60% stocks and 40% bonds. Does it still make sense? That is our topic on "The Informed Investor." I'm Mark Gochnour, joined today by Jake Dekinder and Wes Crill. Guys, this is something that has been hammered for 20 years or so, is 60/40 and there's always better solutions. So let's do this. Let's start with some headlines, come to you guys and we'll get some thoughts. I'm gonna start with some negative headlines on the 60/40. I'm gonna start with my favorite. You ready? "The 60/40 portfolio is on life support. Four new ideas from top managers," and another one, "why investors can no longer count on the 60/40 portfolio." Alright, now let's go to a positive one. And this one is "The classic 60/40 strategy makes sense for investors again." And by the way, the positive one came three months after the one I just read that. Of course it did. Makes sense. Yeah, right. All right. So quick take on some of those headlines. Jake, I'll start with you. Love the life support comment there, right? And then think about the second half of that of four managers come out with new ideas that they wanna sell you products around. Of course they're gonna say the 60/40's dead because this industry's built on packaging some stuff up and selling products and pushing it out to customers, really not even investors there. So that one doesn't surprise me one bit. Hey careful that proliferation or products keeps its podcasts business. So we should be happy about that part. If it was just 60/40 buy and hold works, we'd be dead. We'd be caught after two episodes. We did. repeat, repeat, repeat. But to your point though, I mean this has been going on certainly since we started Dimensional, and probably as long as the 60/40 has been around, it's been taking slings and arrows and I think as you guys are alluding to, a lot of this is correlated with the launch of new products that are gonna fix whatever just went wrong with the 60/40. You get a little bit angry after you do this for a while and a little bit exhausted by it. I mean how many year after year? It's, here's the new shiny object, here's the thing that's coming out. Focus on this thing. I feel like Michael Clark Duncan in the green mile sometimes I'm just like, I'm tired boss. That's what you do. Well we get paid though, right? It keeps us employed here. It's true. So, sure. Alright, do you have some history Wes, if you go back, how did the 60/40 sort of come about and become such a popular idea when it comes to asset allocation? Yeah, I did my best to do sort of a historical deep dive on this. If you just search for the origins of this, you might get 10 different answers at 10 different website hits. But it does seem to trace its origins back to a mean variance exercise where you're going through this process of I have two asset classes. What is the optimal combination of those two that gives me the highest return per unit of volatility? That was the spirit behind mean variance optimization and apparently it did land on a combination which is 60% stocks and 40% bonds. Now that doesn't mean everyone should have that number one, you know that's a noisy exercise. That doesn't imply that whatever happened in the past is going to give you the best return per unit of volatility in the future. It also doesn't mean that everyone has the same objectives, right? So this is for someone who is looking to maximize their return per unit of volatility. Not everyone's trying to do that. Some people actually want to manage their volatility more specifically people going into retirement. Maybe they wanna lean more into fixed income to further reduce that overall volatility even if it means giving up some return. So that seems to be a big part of the origin of 60/40. It's a good point there that it's gonna change their time with people, right? Depending on how their risk tolerance their needs, their liquidity, their age, all of those things change. I think about 60/40 a little bit more as a concept than it has to be a precise 60/40. It's to say listen, you've got broadly diversified stock market, you've got broadly diversified bond market. Can you put elements of those together in some allocation and be real simple on how you move through your financial life? You know, 60, 40, 55, 45, 50. Like I don't really care, right? It's when you start adding additional complexity that I think you can get yourself into trouble. Yeah, and it a little bit of fixed income drastically reduces the level of volatility of the portfolio. I mean it's very clear historically what the benefit has been of 60/40. You know, if you look at a globally diversified stock and bond mix going from a hundred percent equities down to 60/40, your return doesn't get sacrificed too much. Go from 9.9% down to 8.6%, but your volatility drops really substantially. Your worst calendar year goes from about minus 40% for the global stock market to a little bit over minus 20%. So very substantial reduction in the drawdown risk. So you can really see the appeal here. Well I look at the, what's the goal of each one of those components, stocks versus bonds and of course the stock parts I'll say fairly easy. That's just I want to grow my portfolio, grow my wealth over time. The bonds to me gets a little more complex because it can serve a variety of different purposes, right? That's right. It could be stability. Hey I want safety. I got something I have to buy in a couple years. It could be, I do want some higher returns from my bonds, so maybe take on a little more credit risk, maybe a little more term maturity. But it also could be inflation concerns you gotta protect against, it could be some tax sensitivity. So it does get complex on the bond side. It's not as simple as just to say oh 40% in bonds that I'm done. I think about it like my golf bag and Kim Kaiser, our producer told us we weren't allowed to talk about golf. So Kim, I'm sorry we're breaking the rules today. Overruled. This was back like episodes like two, three and four. She's like, yeah, yeah you gotta stop talking about golf too much. But I'm serious. I think about it like that. And it's a good point you bring up, think about equities, right? Long-term growth, that's like your driver and your three wood, right? They serve one purpose, which is crush it down the middle of the fairway. Mine don't go to the middle of the fairway unfortunately. I said that's the goal, right? But your fixed income's like your three iron through your putter, they play a lot of different roles in your golf bag and your golf game and they play a lot of different roles in your allocation when you think about fixed income, capital preservation, total return, inflation protection, tax sensitivity. And so I love having that fixed income component in there 'cause we say 40% but there's a lot of nuances to that 40%. By the way, I love your pen. I don't see any paper or notes but it's already here. Oh it's a total security blanket, right? You ever see that "30 Rock" with Alec Baldwin when he's like, I don't know what to do with my hands. Alright, I wanna go back to another reason I think he gets beat on and this is more recent and you go back to 2022, which was a pretty tough year for bonds. And so I ran a couple numbers here and for this one I looked at the stock market, the Russell 3000, which I think started in 1979. So that's where I'm gonna start some of this data and then the Bloomberg US ag, which is kind of a proxy for the US bond market. And I go back to the ag side, the bond side of those things. And so if you look at the last 47 years where we have the data for that, there were five negative years in the bond side, which is about 10% of the time or so, now I'm going to pull the audience here, I'm gonna quiz the audience. What was the worst year we had in those 47 years and it was 2022, right? Was talking about how 60/40 makes no sense because bonds happened to be negative when stocks were negative. Second poll for the audience would be, how many times in those years, 47 years did the ag have a negative return when stocks had a negative return, one time in 2022. So it just didn't happen to work that one year. So everyone just starts giving up on it and saying, hey, there's gotta be better ways, better solutions out there. So I see, I think that's sort of dovetails with your comment of, hey there's all this product out there, this shiny new product that you go out there and sell as well. That's the very definition of an outlier. And you don't necessarily want to rejigger everything you're doing in your portfolio based on an outlier. You might prepare around that. That's why we did that episode on the fire drills. So you know, you have adequate preparation in your asset allocation. Well I, I wanna mention on your outlier comment, so just going back to the ag side of things, in 2022 the ag was down 13% and the next worst year was 1994 where it was down 2.9%. So that really was an outlier year, right? And we talk about this Jake, there's always a first for something. There's a first to have the worst return we've seen in the act. Well also risk and return are related, right? I mean you think about bonds and people would probably say less risky, less volatile, plays a different role in, and for the most part it does, right? It doesn't mean it's a riskless investment, right? Like you still had interest rate risk, you still had inflation risk, you still had things, you had things that could potentially impact the return of your bond portfolio and that's what you got in 2022. That's part of the deal. Seems like a lot of times when people are throwing dirt on the 60/40 it's because something has gone wrong in markets or they've had some sort of turbulent experience like you back to the GFC or the global financial crisis where because of all that stock market volatility, people are saying well the 60/40 has too much of its volatility coming from the equity side. Well you should be equilibrating that so have equal contributions to your volatility coming from each side. This gave rise to this whole new set of investments called risk parody where you balance the risk between them. More recently people will say, well you know, the fixed income is not adequate to balance your risks so you need these buffered ETFs. Then we do a whole show on buffered ETFs. I think that is a good sort of lesson for investors to keep in mind is every time people say 60/40 is dead, the question is whatcha are gonna do about it? Well if it means you're going to start investing in new products that might have more complexity, less transparency, higher fees, then it's not totally clear you've replaced something with a better alternative. You know, a lot of investments are gonna tie back to the stock market and the bond market, right? You can, you can package it up, you can slice and dice it, you can pull in derivatives, you can do a bunch of stuff in there. But the underlying exposure is what you have to ask yourself. What are you getting? I mean it reminds me a little bit of the value premium, right? I mean how many times has the value premium been rediscovered in a different way? But is that actually the most efficient way to get exposure to the value premium? This kind of brings back some of the other stories that are grinding my years, which is another reason to be suspicious of the 60/40 portfolio is because correlations have been rising between stocks and bonds. We hear that one all the time. You know, I think that ignores the fact that a lot of the reason why correlations rise in periods of market volatility is because that's when the systematic component, the thing that drives prices across asset classes was very volatile. And so that's when your correlations are gonna look like they're higher. But just more specifically to correlations in general, we had an exercise where we looked at the rolling correlations between US stocks and US bonds over time, very long sample period. And then looked at what is the diversification benefit over these same periods, which we define as the percent of variance reduction you get by adding the bonds to the stocks. So we have correlations going up and down like this. The actual reduction in variance was like dead flat through time. Listen, a diversified bond portfolio and a diversified stock portfolio, they play really well together. I mean it's a simple way to accomplish it, right? I mean tequila, lime, juice and simple syrup play really well together, right? Like don't complicate it. I mean you want to think about it like that, right? There are these time tested things that can help you accomplish what you're trying to do, and I mean do you really need to make it more complex? David Booth, our co-founder and and chairman, I think he has a great line where he says, you know, usually complexity does not add value. And it kinda goes back to what you're saying there with your margarita, you got a great mix, don't mess it up. Don't mess with it. I think it's already too complex once you add the lime and the simple syrup. I guess in that scenario I'm a hundred percent equity investor. We won't talk about your extracurricular activities on this. Yeah, yeah, yeah. We've alluded to that before. All right but I go back to this idea of a time period where maybe something doesn't work and do you just give up on it. I'm gonna talk about something, you know, even happening this where, you know we got a family ski ski trip coming up in February and this is one of the worst years we've had in. It's been a rough year for- A number of years when it comes to snow and shoot, we'll even see if there's snow out there, what it looks like here in a couple weeks. But it doesn't mean that all of a sudden I go, okay, skiing's the worst. I hate it, we're done as a family skiing. It just means, yeah, we had a bad draw this year and we'll come give it a shot again next year, right? And odds are it's gonna be a much better experience than we had this year. No, it's a great point. There's outliers, right? It doesn't mean you're not gonna go back to next year 2022. It's an outlier that happens with investing. You, we've said this multiple times in this show of expect the unexpected and if you want to invest for the next 30 or 40 years you're gonna encounter it's different. It's a first, it's the largest, it's the biggest, just get ready for it. Alright, so what do we know that puts the odds in our favor as an investor? And it's kinda those things you gotta focus on. It's you gotta keep your cost down. It's not just the expense ratio but also how a portfolio is managed. You want to keep cost down, turnover low, things like that. You wanna make sure you're diversified, make sure it's transparent, you gotta know exactly what you're getting into. Can I get my money out, liquidity, when and how does that work? So those are all the things you can control. You wanna be informative about whenever something's getting positioned, like hey, here's an alternative to a 60/40. Just be able to answer all those different questions, right? And then of course the financial plan is always really helpful and Jake, to your point, it doesn't necessarily mean it's gotta be 60/40, it could be 70 30, 55, 45, those kind of combinations. But built into that plan is on expectation you're gonna have some tough years. And so when you have those tough years, it's okay because it's built into the plan. So that's kinda how I think about a summary of the 60/40. Anything you guys would add to that? You know, you go back to 2022 and we all had these conversations. You know, you go out and you talk with financial professionals, you talk with financial advisors and don't get me wrong, I'm not trying to shortchange 2022, your stocks are down, your bonds are down, you look at your statement, oof, that hurts in December, I hear you, right? But you ask these advisors like, hey, did your clients really change up the way they were living their lives? Right did they have to make drastic changes to where they lived, how they were spending, the trips that they were on? And for the most part they would say, yeah, it was kind of painful, but everybody kind of kept going. So I think you get this outlier year, but to your point, if you've got a good plan in place, you've built it for that. And now we're several years removed for that. People are back on, equities have been good, bonds have kind of returned to it. So you know, deep breath. I hear you, but deep breath. Yeah, I think you wanna be careful when you know you have something that looks like a replacement for 60/40 ends up replicating a lot of the characteristics of the 60/40. One of my graduate school professors used to say it's okay to reinvent the wheel but don't reinvent the flat tire. And I think that's what people are in danger of when they come after these shiny objects that look like a better solution than 60/40. Boom. Alright, he has the best one-liners. We're gonna get our coffee mugs and t-shirts. Don't invent the flat tire. Alright everybody. Hey, thank you for joining "The Informed Investor" today. We're gonna come back on the future episode and talk a little bit about emerging markets. Had a great year last year. We're getting questions on how and where it fits into our portfolio. And be sure to check out questionnaire. It gives you a chance to submit topics that we can consider for a future episode. So we always love to hear what's on your mind. So thanks again for joining us. Have an awesome rest of the day. Take care.