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Why All 60/40 Portfolios Are Not Created Equally

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Why All 60/40 Portfolios Are Not Created Equally

The financial advice business is all about creating group-think.  That is, they set up a way of doing something, then convince the public that its the best way to do it.  However, there is a big problem with that.  You see, it allows the advisory firm to herd you in with their other clients…like cattle.  Once they have enough people doing this, they get what they truly want: the ability to scale up their operation.  In other words, to grow quickly and efficiently.

The advisory firms also like this herding approach because it is easier to keep track of what clients are doing, because their are very few varieties.  Ideally, they would like all clients to be herded into same exact portfolio.  It is like when Henry Ford first invented the automobile.  The first one that was mass-produced, was simply one version.  As Ford said, the customer could have that Model-T car in any color they wished…as long as it was black.

Back on Wall Street, and a century later, the 60/40 portfolio is all the rage.  60% of your portfolio goes into stocks, and the other 40% goes into bonds.  That’s it, nice and easy, right?  Wrong!  You see, there are many varieties of the 60% and 40% buckets one can create.  My concern is that for many investors, they agree to being part of a viable concept, but don’t really understand what is under the hood, so to speak.  Furthermore, they don’t realize this until it is too late, when a bear market or simple mis-management by the investment firm produces a result that is way off of what their investment objectives are aiming for.

Below you see a chart that shows a very simple example of how the 60/40 portfolio idea can end up surprising investors.  The blue line shows that during the mega bull market of the past 10 years (May 2009 – May 2019), a combination of 60% in the S&P 500 and 40% in the Barclays Aggregate Bond portfolio produced a whopping return of over 154%.  Keep in mind that this is one of the best 10-year periods in modern investment history.

The orange line shows another 60/40 portfolio.  However, here the 60% in stocks is diversified to include non-U.S. as well as U.S. stocks (ACWI).  And, the bond portion is in a security that invests in 1-3 year U.S. Treasury Notes.  That version of 60/40 produced a nice return, but it was less than half that of the blue line.  My concern is that with the over-usage of back-testing, and the overwhelming use of salesmanship in the financial advisory business, this could be a toxic combination.  After all, if someone wanted to show you the best past performance in order to get your greed up and make you say “yes,” all they have to do is show you the blue line.

Related: Why ETF Investors Have a China Problem

Why am I concerned about this?  After all, return of nearly 90% over the past 10 years is a nice consolation price, right?  Well, look at the chart below.  This shows you how those two 60/40 combinations did in the 10 years prior to the one I showed you above.  As you can see pretty clearly, they destroyed wealth equally. That is, over that 10-year period from May of 1999 through May of 2009, both 60/40 mixes produced cumulative returns of under 20% (i.e. under 2% a year for 10 years). In fact, until the very end of the period, the 10-year return was negative. Ask yourself: if the next 10 years are more like 1999-2009, and less like the last 10 years, could you deal with it? Or would you need to adjust your retirement plans, thanks to an over-simplified approach to investing?

The lesson here: go beyond the labels and pitches that 60/40 and other standard Wall Street fare offer.  Focus on you, not on what they want to sell to you.

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