60-40 Portfolio: Not Dead

by | Nov 1, 2023 | Podcasts

Your 60-40 Portfolio Is Not Dead

Despite rumors to the contrary, your 60-40 portfolio is NOT dead.  And the 60-40 portfolio never was dead.  It’s possible we may declare it comatose for the past eighteen months, but not dead.
Have rising interest rates spelled doom for the 60-40 portfolio?

In this podcast (episode #459) Casey and Tom explore the 60-40 portfolio, in light of the current financial landscape.   The guys discuss what has happened over the past 18 months with bonds and the impact on a 60-40 portfolio, particularly the impact on the bond side of the portfolio.   They pull apart an article from the Wall Street Journal questioning the viability of this ‘set it and forget it’ strategy of employing a 60-40 portfolio in a 401k account.

Over the years, this 60-40 portfolio strategy was promoted frequently to 401k participants as a method to invest well.
Nothing is “set it and forget it.”

Tom & Case also delve into the importance of understanding your stock and bond investments – and how a 60-40 portfolio can be tailored to suit various investment types.

But what happens when bond yields change?  The guys touch on potential impacts on your stock and bonds, and your 60-40 portfolio.  Also covered is the critical role of liquidity and correct portfolio allocation in achieving your target returns, along with an exploration of historical market returns and their impact on stock prices.   Casey & Tom also take a critical look at the 60-40 portfolio in the future – will it hold up in the coming years?

Tune in for a robust discussion that might just reshape your investment strategies.

Internal Links for “Your 60-40 Portfolio Is Not Dead”

Catch all our Mullooly Asset Podcasts right here
More from us on 60-40 portfolio:
Is a 60-40 Portfolio Still Good?
Is the 60/40 Portfolio Dead?

External Links for “Your 60-40 Portfolio Is Not Dead”

Morningstar
CNBC 60/40 portfolio certainly isn’t dead
JPMorgan 
WSJ article
Ben Carlson
Corey Hoffstein 

 

Transcript for “Your 60-40 Portfolio Is Not Dead”

Casey: 0:29
Hello and welcome back to the Mullooly Asset Podcast. This is Episode 459. I’m your host, Casey Mullooly, back at the table with Tom Mullooly and we are going to talk about the 60-40 portfolio.

Tom: 0:45
Yeah, the set it and forget it 401k. Is anything “set it and forget it” other than the midnight infomercials that they sell stuff on TV?
Can any investment really be a “set it and forget it”?

Casey: 0:59
That’s a good question! And I think this 60-40 debate of whether it’s alive or dead seems to crop up every couple of months or at least every other year. I know we’ve talked about it before and it’s this idea that the 60-40 portfolio is 60% stock exposure, 40% exposure to bonds and the portfolio is as long as you keep that allocation in line, then you can just forget about it and let it ride.

Tom: 1:35
That’s a big blanket that gets thrown over a lot of different portfolios, a lot of different accounts, a lot of different – even allocations! 60% into stocks…

Tom & Casey:
What stocks?

Tom: 1:36
Yeah, I beat you to it.

Same thing on the bond side.
Are we going to go in just short term bonds?
Are we going to buy the aggregate bond index?
Are we going out to the longer end of the yield curve?
What are we buying?
International stocks?
Are we going to have small caps?
Are we going to have just the S&P 500?

You can slice and dice this a million different ways. And so when people say – and they talk about this every morning on Bloomberg TV “60-40 is dead,” or at least for the past 18 months, that’s a lot of what they’ve been talking about.

Casey: 2:27
Right. So the narrative is that bonds have taken it on the chin, because interest rates have gone up from zero to five percent in the last 18 months or so. And as bond interest rates go up, bond prices go down.

Bonds are usually viewed as the stable side of the 60-40 allocation. When it is compared against stocks, stocks are usually more volatile than bonds are, but bonds, at least over the last 18 months, have proven to not be that stable ballast that people look for in their portfolios.

Stocks have been kind of a mixed bag in terms of stocks. Again, what stocks are we talking about here? 2022 was a down year for stocks, but the start of 2023 was very good, especially for these big names, stocks and more of the internet, nasdaq-type names. Where does that leave us now? I know we both read a Wall Street Journal article before we turned the mics on, so if you want to spell out what the article described and your thoughts about what point it’s making.

We’ll link to it in the show notes.

Tom: 3:46
Unfortunately, Wall Street Journal is one of those paywall sites. So if you don’t have a subscription, sign up. They’ll give you a couple of articles for free. I think it’s worth your time to go through this. The headline of the article is “Your set it and forget it 401k made you rich. No more.” Written by Spencer Jakab.

I have so many things that I want to talk about with this. This could be, it won’t be, but this could be a two-hour podcast. This could be a Joe Rogan episode!

Casey: 3:50
The author starts out by saying for four decades, patient savers have been able to grit their teeth through bubbles, crashes and geopolitical upheaval and won the money game.

Tom: 3:55:
Not without a lot of stress and anxiety and worry about “am I doing the right thing?” Very few people – not named Buffett and Munger – have second-guessed every single move they’ve made over the last 40 years.

Casey: 4:49
Let’s see. That brings us back to 1983, correct? So we’ve got the 87 crash in there some 1990 Recession.

Tom: 4:59
We’ve got 1998 Dollar crisis. We’ve got the 1999 2000 dot.com explosion. The Nasdaq went up to 5000 from 1500. Then we had a two-year recession. With 9-11 in the middle of that. Then we had 2008 Market meltdown, 2009-10 into 2011, recession.

What am I missing?

Casey: 5:26
Even more recently 2013 flash crash (right),
2015, Brexit,
2018, when they started to raise rates, they moved the rates off zero, the market freaked out.
2020, covid
And now here we are in 2023 with with rates rising from zero to five percent in 18 months. And the market has gone down slightly.

I think if you asked anybody what what the market would do if rates increased by 500 basis points in that time frame, they would say that we were down 30, 40, 50 percent. And yet, through all these things, this author writes that you “won the money game.”

Tom: 6:15
Not without any kind of stress.

So now yields on treasuries are at their highest since 2007-2008, causing their value to plummet.

Have they really plummeted? I mean, look at the short end of the yield curve. Those values haven’t really done poorly at all. If you go out further and further, you start to see more damage to the value. The real damage is in the 20 to 30 year maturities.

Casey: 6:47
What benchmark did he use it? Is it the five year?

Tom: 6:53
He didn’t even say, just said treasury yields.

Casey: 6:53
Yeah, I think you know, in that five to seven year range …it’s, you’re down maybe between 10 and 15 percent. Maybe.

Tom: 7:01
That’s far from catastrophic. From my perspective it seems like it hurts more – because folks invest in bonds primarily because they provide some measure of stability – a little bit of what we call “ballast” in the portfolio.

And they haven’t done that now in a year and a half.
Does it mean they’re broken?

Casey: 7:28
No. I think the timing of this article is the most questionable part of it to me. If the author of this article wrote it in October of 2021, then he would have probably been probably wouldn’t have gotten published, but he would have been right then, because I think the risk that he’s talking about With this rise in interest rates has already happened. Right, it happened you’re through it.

Tom: 7:51
Yeah, again, we don’t like to predict or forecast, but we’re already seeing inflation numbers coming down. So the Fed is running out of reasons to raise interest rates. Do they have an incentive to lower rates interest rates?

Casey: 8:09
I don’t think so.

Not yet. I brought my own article. This one is from Ben Carlson – because I know he wrote about it. This is from September. But I just I had some stats to share regarding the 60-40 portfolio. Since 1926, the S&P 500, or “stocks,” have gone up roughly three out of every four years. The five year treasuries have experienced positive returns in nearly 88% of calendar years since 1926.

Seven out of eight years.

So this whole narrative that stocks and bonds move in different directions isn’t actually the case. They tend to move in the same directions, just to different magnitudes. I think that is where you look, for you know, if stocks are down 30%, bonds are probably going to be down too. But hopefully it’s 10% down, instead of that 30%.

I think that is an important part which, by the way we saw in 2008,.

Tom: 9:16
In 2008, when the market went down, depending on which yardstick you’re using, the market went down 30%, 40%, in some cases, 50%.
And, again depending on the yardstick, bonds went down too. But they went down not even close to what some of these markets did.

Casey: 9:35
So let’s talk about this whole “regime change” narrative. Because I think that that is one of the things that’s driving the fear in the bond market is that from 1981 to 2021, their rates went from 15% to zero, basically.

So Ben looked at how stocks performed and how bonds performed. He looked at from 1926 to 1980, which could be viewed as a rising rate environment. And then he looked at 1981 to 2021, or falling rate environment.

From 1926 to 1980, stocks annually returned 9.4% per year.
Bonds returned 3.7% per year. So that’s an arising rate environment.

In a falling rate environment, from 1981 to 2021, stocks earned 11.1% annually.
And bonds earned 6.5% annually. So more than in the rising rate environment.

But the rising rate environment, those returns are still good.
They’re just not as good as they were in a falling rate environment.

Tom: 10:54
I think that’s part of it too — is that, yes, if you have owned bonds for the last few years, you have some damage in your portfolio.

However, you can also look at bond yields today and say, “hey, for the first time in a long time, I can get 5% on a one year CD at a bank.”

You don’t have to do something exotic to get 5% for a year. You can walk down to your corner bank and get that.

For many, many years, until last year, I used to use this “joke” often in client meetings. I would hear people would say, “oh, I just want to put it in something safe like a CD (edit: for one year).”

I would laugh and say “when was the last time we got 6% on a (edit: one year) CD? 1994!”

If we hit 6% at the end of this year or beginning of 2024, it’s going to be a 30 year gap between doing that.
But it’s not something that you really… that’s just parking money. That’s not something that you can plan on. Those rates are going to change.

Casey: 12:03
You know Ben had had some more good numbers here regarding exactly that. Because I think what you were talking about there — when we could earn nothing on our bonds, or fixed income …we had to kind of ‘reach’ for a return from the stock side of the portfolio. Which could lead people to taking more risk than they otherwise should have.

So Ben wrote if your target annual return for a 60-40 portfolio is 6%, but bonds yield 1%, you need almost 10% per year from the stock market.

Tom: 12:39
Right, if the 40% side, the bond side, is only generating 1%, then the other side has to work twice as hard to get you to where you’re going.

Casey: 12:50
But if bond yields are 5%, you only need less than 7% from the stock market to hit your goal.

Tom: 12:58
This is really important. Because when we are putting together portfolios, we are not talking about what the market’s gonna do between today, the day you’re listening to this episode, and the end of the calendar year – or even the end of the next calendar year.

We are taking a longer-term approach with this money. That’s on the stock side, the equity side of it. That’s so important. People really lose sight of that.

The other thing that I’ll point to, is it’s easy to take potshots when you don’t have an allocated – or properly allocated – portfolio and say, “well, the market returned 10%. How come we only made six or seven?” Well, because we’re in a properly allocated portfolio. We’re in something that’s gonna give us some relief by owning some bonds.

Casey: 13:53
And also probably keep you liquid. Which forces you to not have to sell your stocks – at a loss – to pay bills. Which is something we talk about all the time and that is worth its weight in gold. Having that liquidity and having that cash on hand to meet your demands is what planning is all about.

Tom: 14:16
Yeah, so we talked about in the Wall Street Journal article — and I apologize for flipping back and forth between the two — but they talked about how, prior to the 60-40 idea concept really taking off in the early 80s, they talked about the prior generation was not making any money.

They said, for example, a family setting aside $1,000 for their toddler’s education at the end of 1965. If they had put it in a 60-40 portfolio, they wound up with $785 in real terms by their senior year of high school in January 1982.

That’s actually pretty close to my numbers.

But not mentioned in that illustration is the fact that FDIC-chartered banks were paying 5.25% per year – on passbook savings accounts! And people went crazy, driving all over town, (edit: years later) to try and find a quarter point extra on a CD — because people were getting double digit yield on certificates of deposit for 6-12 months.

So yeah if you were in a 60-40 portfolio may not have worked out. But it sure was tempting to go and look around at other alternatives that were out there. Without any risk.

Casey: 15:39
I hate to say that those dates are cherry picked, but it’s like inflation in the 1970s was the worst that it’s ever been. He’s got to (kind of) prove his point there. I think going back to that cycle essentially. You know, late 1960s to early 1980s, you capture one turn through the cycle. I think going back to pre-World War II, or the 1920’s – when we started getting historical market data. I think that and seeing how that compares to where we are today is probably a better example.

But point taken that it’s possible that it could happen in the future as well.

Tom: 16:22
Sure. Towards the end of the article, he wrote that one unnerving possibility is that the Fed could reverse course and push rates down – if today’s high rates cause a recession or a stock market meltdown.

I think we would have seen it by now. Last year, the market, at one point, was down 22%.

Casey: 16:47
Again, I don’t know if he’s writing this article for people who have owned the 60-40 portfolio or people who are allocating fresh dollars to a 60-40 portfolio today. Because, I think if you’re putting new money into a 60-40 portfolio today, you’re probably in a pretty good position… with a bond side that’s offering 4% and 5% yields.

Tom: 17:11
That’s juicy.

Casey: 17:12
Yeah, and stock. I think he used a valuation metric to say that stocks are overpriced, and probably gonna fall because of that.

And we’ve talked numerous times on this – in videos and podcats about how valuations aren’t a good …they’re not a timing mechanism. People keep making that point that, “oh, stocks are expensive and they have to go down in value, as a way to work off their how expensive they are.”

And it’s like just because they are expensive – according to your ratio – doesn’t necessarily mean that they have to go down in value. It’s just they can get more expensive, sure, and they don’t move in straight lines, yeah.

I had one more thing. This was from Ben’s article, it was actually from Corey Hoffstein. And it just provides numbers to the point of “starting bond yields are more important to bond returns than the price action of bonds” sometimes.

Tom: 18:14
I know that Brendan has mentioned this in several discussions. And it is really worth repeating because it’s I think if people understand this when they’re investing in bonds, they’ll have a greater grasp of what to expect – going forward, when they put money into bond funds or into bonds in general.

Casey: 18:36
So Corey assumed, or Corey looked at, the period between 1981 and 2017. And this was deemed a falling rate environment.

In 1981, treasury yields were 15% and then they went all the way down to 2%. He looked at where are the returns from the bonds coming from over that time period?

He found that they annualized an 8.7% return over that time period. 6.24% of that return came from the starting coupon, 0.24% came from what he describes as “roll” and 2.22% came from what he described as shift or change in price.

I just want to repeat that coupon yield – the starting coupon yield – accounted for 71% of that 8.7% annualized return.

Tom: 19:30
So let’s bring this forward. If you were buying bonds, say, in 2020, when interest rates were zero, what should your expectation be of your returns for bonds?

Casey: 19:33
In general, it should be minimal.

Tom: 19:36
And if you’re doing the same thing today and we can get – you know we don’t want to quote specific yields – but in general, the yield curve is pretty flat at the moment. We’re recording this in October of 2023.

Two years are close to 5%
10 years are close to 5%.
30 years are also in the same place.
So we’re looking at basically a flat yield curve around 5%. What could someone expect?

Casey: 20:14
Take 70% of that and you get 3+% from just the coupon yield and then depends on what – you know – the price of the bonds do. And that’s going to depend on where rates go, which is anybody’s best guess at the moment.

But I think, the point being, the majority of a bond’s return is dependent on the starting coupon yield.

Tom: 20:42
Yeah, that’s so important. I know Brendan kind of uses an even a simpler “back of the envelope” number …whatever the current yield is when you buy. That should be your expectation for the life of the investment. Not per year, because there’s going to be some years where you make 10% in bonds. And there’s going to be years where, like last year, where you lost money in bonds. But overall, for the entire period, the duration, it’s going to be pretty close to what the coupon yield is when you buy.

Casey: 21:11
Right. And you don’t want to be a forced seller in any situation. But especially when it comes to bonds. Because I think matching the duration to your actual time horizon or your need for the money is an important consideration as well.

Tom: 21:28
As long as the tape is still rolling. I do have one thing that I want to say about being “a forced seller.”

If you happen to see a price quote on your statement, or… there used to be a section in the newspaper where they would actually post (listed) bond prices for some widely owned bonds – not a lot of bonds, because bonds – there’s millions and millions of different issues.

The price you get for your bond depends on several things. It depends on the terms of the bond. How far away for maturity are you? What’s the credit rating of the bond? Did it (rating) change from the time you bought it? How many bonds do you have to sell? People miss that.

When we’re talking about quoting yields on treasuries, the price that we’re looking at is based on one million dollars face amount.

So if you want to buy a $50,000 T-Bill, you’re getting a different price. I should say if you want to “sell” you’re going to get a different price.

If you have 10 municipal bonds from the State of New Jersey, and you need to sell them, you are not going to get a good price. It’s just the way it is.
Those things should be held to maturity.

You do have some liquidity, if you need to get out. But you’re going to get slaughtered, relatively speaking, when you sell.
People don’t even know that.

They’ll look online, or they’ll look on TV and they’ll see that their stock or their ETF is trading at a particular price. They can get that price. Boom,
Go online. Or they can call their broker and they can get it done immediately.

If you speak to your advisor about selling some bonds, you’re going to find a very different story. A very different story.

Casey: 23:17
Yes, it’s important to note that there’s individual bonds. And then there’s bond funds – which work differently than individual bonds. These tend to be more liquid, but bond math is tough and it’s complex. There’s a lot of different factors that go into it. You really have to understand what you’re getting yourself into, before you invest in these things.

Any last words:
The 60-40 portfolio, is it alive or dead? It seems to me that we think it’s alive, I think 60-40 portfolio is very alive.

Tom: 23:52
I think we’re going to look back at 2022 and 2023 and discover that this was a terrific time to be a 60-40 portfolio owner.

Casey: 24:04
You heard it here first. And that is going to wrap up episode 459 of the Mullooly Asset Podcast.
Thanks as always for tuning in. We’ll be back with you next week.

Speaker 3: 24:14
Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.