Why the 60-40 isn’t dead, it just needs to be modified
Recently people have been ringing the death knell for the 60-40 portfolio because bonds are going down as the same time as stocks. Many are saying the classic 60/40 portfolio is DEAD. Many people retiring are upset because their portfolios are down -25% and the bond portion hasn’t provided much protection.
Can the 60/40 portfolio be improved?
I personally don’t think the 60-40 portfolio is dead, I think the fixed income portion just needs some changes. It might also help to divide the portion into cash or precious metals as well.
For the purposes of this article, let’s assume a 60% equity exposure using basic total market exposure. The first change I’m going to make is instead of using the Total Bond market, (which I’ve never been a fan of) I’m going to use Intermediate Treasuries. These are treasuries that come due in the 7-10 year range. You miss out on the risk of corporate bonds (minimizing downside risk) and you don’t take on the interest rate risk of long-term bonds (TLT for example).
Another thing I decided to do is look at what happens if you take the 40% bond allocation and half it (20%) and put the other 20% into either gold or cash. I’m not advocating you do this because a lot has changed in the precious metals market since the 70’s and 80’s; however, it’s worth taking a closer look.
I think in order to get a grasp on how these portfolios will perform it pays to look at time periods where we had high inflation (not the last ten years). So, for the purpose of this study, I’m going to look at the following periods:
1972-1992, 1972-1982
What performed well during that time? What helped you from incurring large losses?
Here are the portfolios for reference:
- 100% US equities
- 60% US Equities + 40 % Intermediate Treasuries
- 60% Equities + 20% Intermediate Treasuries + 20% Gold
- 60% Equities + 20% Intermediate Treasuries + 20% Cash (On the separate chart)
Notice that from 1972 to 1992 the 60% Equities + 20% Intermediate Treasuries + 20% Gold portfolio outperforms. Not only does it outperform, but it does so with a lower Max Drawdown (only -20.6%).
100% equities suffers a max drawdown of -46% while all of the other portfolios drawdown less than 30%. The Sortino Ratio for the more balanced portfolios are all higher. Adding cash instead of gold almost performs as well as a 60/40 portfolio with the Intermediate Treasuries. It also lessens your drawdowns to -26%. This was during a high inflation environment; therefore, it didn’t pay to leave your money in cash. You were better off being in bonds or gold.
Let’s look at the time period 1972 to 1982
60% Equities + 20% Intermediate Treasuries + 20% Cash CAGR= 8.72% with a max drawdown of -26%
60% Equities + 20% Intermediate Treasuries + 20% Gold CAGR= 13.3% with a max drawdown of -21%
60% equities + 40% Intermediate Treasuries CAGR 8.51% with a max drawdown of -27%
100% equities = CAGR 8.39% with a max drawdown of -46%
I also ran an additional portfolio where I divided the 40% of bonds into 20% intermediate and 20% ten year Treasuries. The CAGR was 8.31%. It turns out the addition of the longer-term treasuries hurt the portfolio. Makes sense as interest rates are rising.
Once again, the same portfolio with the addition of gold is the star of the show. Beating out the other portfolios by over 4% CAGR. What’s interesting here is during this time of high inflation, 100% equities performed worse than anything else. Holding a percentage in cash actually helped out your returns, just not as much as gold.
A common argument is that gold will never outperform like this again. That it was coming from a place of being undervalued. No one knows. DISCLAIMER-I don’t own any gold in my portfolio, only silver. Gold tends to be less correlated with the stock market than silver. It could be that Gold one day shines again and Warren Buffett wishes he owned some, ha.
Another thing that seems to hold true for today as well is that Long-term Treasuries did not help your portfolio. I’m sure an argument can be made that by reducing the duration of your bonds, you are also reducing your income (which retirees depend on). This sort of thing could possibly be replaced via dividend stocks (not to mention purchasing equities at lower values therefore boosting dividends).
Also, you could simply buy Treasuries instead of bond funds at the new higher rates (requiring a bit more work). The longer-term bond funds would eventually pay you higher yields; the issue is they take a bit to “catch up” with yields. Meanwhile, your income is not enough and the price of the fund is dropping. This is what we are seeing today.
Another thing I will throw at you is if you run these same analyses with Mid-Cap or Small-Cap value funds you get better results. Value outperformed growth during this period of time. That is for another article. However, I think we will probably see this play out over the next year as well-Value stocks will be a better place to be in this high inflation/high interest rate environment.
I am not a financial advisor, none of this constitutes investment advice. I am simply sharing some data with you all as I decided to investigate things for my own portfolio. My own portfolio is more of a 70-30 portfolio, at least that is what I try to balance it out to. Where the 30% is a mix of bonds and cash at various times.
I will leave you with these numbers: From 1972 until today CAGR of 100% equities is 10.13%, the ‘winning’ portfolio from above has a CAGR of 9.76%. The max drawdowns were -56% vs. -27.5%. It turns out on a risk adjusted basis the balanced portfolio did better 🙂
