I recently began wondering how people did long-term that held a 50% stock and 50% bond portfolio. One could say, I have no idea how stocks or bonds are going to perform in the future, so I’ll split the difference, and not worry about it. Is 50-50 a safe bet? What are the risks associated with a 50-50 portfolio? Those are some of the questions I’ll address today.
I’ll begin by addressing this statement:
“With a 50-50 portfolio, I have a 50% chance of being right.”
Except, this statement is false. Why? Consider the following scenarios:
- Stocks go up, Bonds go down
- Bonds go up, stocks go down
- Stocks and Bonds both go down
- Stocks and Bonds both go up
- Stocks and Bonds both do nothing (or some variation of one doing nothing while the other moves)…otherwise known as TORTURE!
People forget to consider the third possible outcome because it doesn’t happen often enough. Yet, this is what’s currently happening. At the start of 2022, both stocks and bonds went down at the same time (A product of inflation and rising interest rates). Let’s look at some of the pros and cons of a 50-50 portfolio:
50% bond & 50% stock portfolio
Pros of 50-50 Portfolio
- Less volatility
- Less max drawdown
- Little time required to manage the portfolio
- Less risk?
Bonds have less volatility than stocks. By adding 50% bonds to the portfolio, you end up with much less volatility than if you used 100% equities.
Lower Max Drawdown
Bonds typically have less of a max drawdown than stocks. For example, since the 1920’s, bonds max drawdown was -31%; meanwhile, for stocks it was -51%. That’s 20% more of a drawdown. Keep in mind, this is a super rare event and you’ll find most of the time bonds don’t have such a bad drawdown.
Since 1972, the max drawdown for the 10 year Treasury was -15.76% vs. -51% for stocks.
A 50-50 portfolio does not take much time to manage. Essentially, all you are looking at is annual rebalancing to make sure you maintain the 50-50 asset allocation. The fewer ETFs or mutual funds you use to make the 50-50, the less time it takes to manage it. Of course, if you’re looking at a 100% stock portfolio, there isn’t an advantage. Neither requires much time to manage.
I think one has to be careful when they say less risk; hence why I added the question mark above. Bonds are perceived as carrying less risks than the stock market and most of the time this holds true. However, it depends on how you quantify ‘risk.’
You could have other risks. For example, not having enough for retirement if you only use bonds for returns. If you add bonds to your portfolio, will it dampen your returns so much you end up with much less money? We can’t tell the future, but that COULD be a concern with bonds in certain environments.
Cons of the 50-50 Portfolio
- May not have enough for retirement (return dependent)
- As bond rates increase, prices drop (interest rate risks)
- Inflation Risks
- Have to match duration to your retirement period
Returns not enough
If you look back over the last 50 years, you’ll see that equities outperform long-term. 9 out of 10 years, stocks beat bonds. They have offered the highest CAGR’s and annualized returns. Simply put-to maximize returns, you maximize your equities exposure. However, these returns are HIGHLY dependent on the timing of your investing. Known as sequence of returns.
There are 10-year periods where the stock market was flat or had poor returns. During these times, even investing in stocks left you with ‘not enough money.’ The point of a 50-50 portfolio isn’t really to offer you the most returns. It is to offer you good risk -adjusted returns. To give you returns while allowing you to worry less about what your portfolio is doing.
Bonds are dependent on Interest Rates
Bonds move up and down with interest rates; they are basically inversely related. As nterest rates increase, bond prices come down. The returns of bonds will depend on macro-economic conditions. Here is where the actual vehicle of investment comes into play. Are you buying actual real Treasuries or are you buying a Treasury Bond ETF? If you are buying bond ETFs, the price of your bond ETFs will take a hit in periods of rising interest rates. If you buy actual treasuries, then you are paid your principal plus the coupon rate if you hold it to completion (ie. less risks!)
This is the main risk we are seeing play out in our current environment. With inflation at 9-10%, then a bond’s coupon of 3% is not helping your purchasing power grow. The bond’s payment isn’t keeping up with inflation. Of course, the stock market this year hasn’t kept up with inflation either; it’s down worse than bonds. One of the primary reasons for investing is to outpace inflation so you don’t lose purchasing power.
Matching Duration to Investment Period
If you are going to use Treasuries instead of something like the Total Bond Market Fund, you have to match the bond fund to your particular investment period. In short, if you have 20 years before retirement, then something like TLT or a 20 year bond ETF is okay. However, if your time to retirement is shorter, you are supposed to buy an intermediate length bond ETF. You match your duration to length of retirement and you should come out okay, even in periods of rising interest rates. At least in theory!
Historical performance of the 50-50 Portfolio from 1972 until now
Portfolio 1 is 100% equities, Portfolio 2 is 50% Total Market & 50% 10 year Treasuries.
The 3rd portfolio is something I made up consisting of the following: 15% total market, 15% small cap value, 10% total international, 10% emerging markets for the stock portion. For the bond portion, it is all Total Bond Market.
As expected, the 100% equities portion had the higher return at 10.2% CAGR vs. 8.35% for the 50-50 portfolio. My made-up portfolio only had a CAGR of 7.23%.
Please keep in mind, this says nothing about future performance. US equities have outperformed international for the last 10 years (In the past, this hasn’t always been the case). Also, bonds have done fairly well the last 10 years due to dropping interest rates.
I think the main thing to get out of this is the lower standard deviation and lower max drawdowns of the 50-50 portfolio.
If I pick different starting dates (like 1998), Portfolio #3 does better than the simpler 50-50 portfolio. Shift the start date out further to 2003 and the opposite holds true. At no long-term point does the 50-50 portfolio outperform the 100% equities portfolio.
Construction of the 50-50 Portfolio
There are a number of ways you can go about creating a 50-50 portfolio. Here are a few
- VTI 50%
- TLT or BND 50%
This is about as simple as it gets. 50% in a Total Market ETF and 50% in a long-term Treasury bond fund or Total Bond Fund. If we look at the performance of this since 2007 (As far back as the data goes), we see it had a CAGR of 6.66% vs. 9.48% for 100% VTI.
If we zoom out further and start at 1972 (Using the 10 year Treasury) we see that it has a 9.07% CAGR vs. 10.46%. This also had half (-23%) the max drawdown of a 100% equities portfolio. Pretty impressive. However, keep in mind that this was mainly over a period of dropping interest rates.
Personally, if I knew I could get a CAGR within 1-1.5% of a 100% equities portfolio using a 50-50 approach, I’d be up for that!
If this is too boring for you, you could break things down into further sections to gain more international or small cap value exposure. I’m not saying you have to do this, just showing you an example of how to make it more diversified.
- 20% VTI (Vanguard Total Market ETF)
- 20% AVUV (AVUS Small cap Value)
- 20% VXUS (Vanguard Total International)
- 20% VWO (Vanguard Emerging Market)
The bond portion could breakdown like this to cover more durations or even international.
- 25% TLT (Ishares 20 year Treasury)
- 25% IEF (Ishares 7-10 Treasury)
- 25% IAGG (Ishares Aggregate International)
- 25% SHY (IShares Short Term Treasury)
The more complex you make this, the more diversified you are. However, the more in expense fees you acquire as well. The whole appeal of a 50-50 to me is the simplicity and the little time investment needed to manage it. The more ETFs you stack in there, the more time it takes to keep them properly balanced.
I hope you got something out of this dive into the 50-50 portfolio. Come up with some ideas of your own, run them through portfolio visualizer and see what you think. It’s probably not appealing to younger investments; however, as you get closer to retirement, it COULD be something to consider. I think it might be a good choice for someone that already has lots of wealth and is a high income earner. You’ve already won, so you don’t need maximum growth.
WISHING YOU THE BEST ON YOUR INVESTMENT JOURNEY!