Someone Telling You to Ditch Your 60/40 Retirement Allocation?
Cherished stocks and bonds ratio is under fire, but fixes carry risk
For decades, the investing sweet spot for combining high-return potential (stocks) with nerve-calming lower risk (bonds) has been the so-called 60/40 balanced portfolio.
A mix of 60% in U.S. stocks and 40% in intermediate term Treasuries generated an annualized return of 9.5% since 1972, according to the Portfolio Visualizer website.
Full disclosure: That was not quite one percentage point less than the 10.4% return if you had 100% of your money riding on stocks during that stretch. But hoo-boy, for that extra 90 basis points you had to withstand nearly 60% more volatility, which by definition requires longer bouts of patience once a bear market hits.
A 60/40 balanced portfolio (rebalanced annually) took two and a half years to recover its losses from the 2007-2009 meltdown. The all-stock portfolio needed nearly four and half years to recover its losses.
Lately, though, 60/40 is getting dissed by various corners of the investing world. The primary concern is today’s very low yields on U.S. Treasury bonds. That suggests the 40% of a 60/40 mix is going to be hard pressed to generate much of any return.
Bank of America Merrill Lynch is on the record that the balanced strategy “won’t survive the 2020s.” Morgan Stanley took a more nuanced approach, pointing out that the strategy is expected to produce much lower returns in the coming decade, without explicitly suggesting it is doomed.
And in early February, Wharton School of Business professor Jeremy Siegel proclaimed on CNBC that 60/40 “just won’t cut it” for retirees who want to generate income to live on. Siegel is backing a 75/25 approach, which is at the heart of new strategies at WisdomTree Asset Management, where Siegel is a senior advisor. (For the unfamiliar, Siegel is the author of the influential investing book “Stocks for the Long Run.”)
The basic argument that Siegel and others are making is that you can earn more income from stocks that pay a dividend than you can from high quality bonds.
No arguing with that. The SPDR S&P Dividend ETF has a current yield of about 2.5%. That is indeed more than what you’re likely earning in a core bond fund, which is the popular choice in retirement plans. The iShares Core U.S. Aggregate Index ETF has a 2% yield, as does the Vanguard Total Bond Market Index fund. Those bond funds own a mix of high quality U.S. corporate, Treasury and government-agency bonds. The classic 60/40 strategy calls for keeping the 40% in intermediate term Treasury bonds. Right now that means accepting an even lower yield. The Vanguard Intermediate-Term Treasury fund currently yields 1.5%.
But there’s a large and dangerous trade-off for shifting more into stocks. All stocks, even dividend payers that have a history of profitable growth, are always going to be more volatile in bad markets than a portfolio of high quality bonds.
The question you need to ask yourself is how you will handle bigger losses in a bear market if you load up on dividend stocks and lighten up on bonds. Successful investing over the long term boils down to how well you keep your head when stocks are falling.
For near retirees, consider what happened during the financial crisis. Over the course of the U.S. market meltdown that ran from mid-2007 to early 2009, the SPDR S&P Dividend ETF lost 49%. If you had kept 75% of your money in that ETF and the other 25% in the Vanguard Intermediate Treasury fund, you would have lost 36%, according to Portfolio Visualizer. If your stock/bond split was 60/40, your portfolio fell 27%. Granted, that was an epically painful bear market, but the message is clear: Bonds help soften the fall.
If you are sure you can stay calm during a market meltdown, owning more stocks may be worth considering. For everyone else, it might be wiser to stick with a slug of bonds as a risk dampener and then consider other ways to compensate for the fact that bonds are not likely to return much over the next decade (and 11 years into a bull market for stocks, that side of your portfolio could also underperform in the coming years). Here are some strategies to make this more conservative approach work for you:
Keep your investing costs down. In a world of expected low returns, paying the lowest possible annual expense ratio becomes ever more important.
Cover your basic living expenses with guaranteed income. If you can set up your retirement spending so that all your monthly essential bills are covered by Social Security and a pension if you have one (and perhaps an income annuity), that’s going to help with the sleep. You know that no matter what happens in the stock market you’ve got the basics covered with income that will not waver. In that scenario, it can be easier to shift a bit more into stocks, given you aren’t relying on this part of your portfolio for essential living expenses. For instance, maybe instead of 60/40 you consider 65/35.
Work a little longer. Working even part time for a few more years, so you don’t have to tap your retirement savings just yet, extends the life of your portfolio, without taking on any more market risk.
Reduce your living expenses. Wall Street will never suggest pulling this lever. It only dishes up strategies – more stocks, less bonds! – that expose you to more market risk. Yet lowering your living costs can be an elegant and guaranteed way to cope with a decade (or more) of lower expected returns. The less money you need, the less money you need your portfolio to generate.