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 Is the 60/40 Portfolio Broken?

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For decades the stan­dard rep­re­sen­ta­tion for a bal­anced port­fo­lio has been the “60/40”- 60% equi­ties, 40% bonds. Although most investors diver­si­fied beyond this mod­el and incor­po­rat­ed small caps, for­eign stocks, high yield bonds, and per­haps some­thing more exot­ic like REITs or com­modi­ties, a sim­ple mix of 60% S&P 500 and 40% Bar­clays U.S. Aggre­gate Bond is often the short­hand def­i­n­i­tion of a bal­anced port­fo­lio.

For a gen­er­a­tion, this sim­ple approach worked well. Stocks pro­vid­ed cap­i­tal appre­ci­a­tion and div­i­dends, albeit with a dose of volatil­i­ty. Bonds pro­duced yield, cap­i­tal appre­ci­a­tion as rates fell, and act­ed as a volatil­i­ty damp­en­er when stocks went south. One could have met actu­ar­i­al demands of 6%, 7%, or even 8% via this sim­ple port­fo­lio.


60-40 vs SP 500 vs US Bond Agg Index - Comparison Jan 1979 - June 2016 | Swan Blog

Look­ing at the above num­bers, one might be tempt­ed to say, “If it ain’t broke, then don’t fix it.” How­ev­er, such an approach is dan­ger­ous­ly naïve. The sim­ple truth is that the like­li­hood of bonds post­ing returns any­where near their his­toric lev­els is close to zero. In the graph below we can see the cur­rent yield curve. An investor pur­chas­ing 10, 20, or 30-year bonds will be hard-pressed to out­per­form infla­tion, while some­one park­ing their mon­ey in the short end is essen­tial­ly lend­ing their mon­ey for free.

Yield Curve as of June 2016 | Swan Blog

What impact does this have on the stan­dard 60/40 port­fo­lio com­po­nents? Let’s run a sim­ple alge­bra­ic cal­cu­la­tion. Assume we have a stan­dard 60/40 port­fo­lio mix and the tar­get return for the over­all port­fo­lio is 8%. If we assume that the 40% posi­tion in fixed income will return 2%, what would the remain­ing 60% in equi­ties have to return in order to lift the port­fo­lio up to 8%?

Solve for X - Required Returns for Stocks for 60-40 portfolio | Swan Blog


The answer might come as a nasty sur­prise: 12% 


Required Equity Returns for Various Bnd Yields - 60-40 Portfolio | Swan Blog


(This exam­ple uses sim­ple, arith­metic returns. The exam­ple does NOT take into account the impact of com­pound­ing).




What To Do If the 60/40 Portfolio is Broken?

Giv­en these cir­cum­stances, investors are left with an unap­peal­ing set of options, which include:

  1. Low­er­ing the return expec­ta­tion for the over­all port­fo­lio
  2. Tak­ing on more risk and increas­ing the equi­ty por­tion
  3. Sim­ply hop­ing that the cap­i­tal mar­kets will do bet­ter than expect­ed and deliv­er high returns

Hop­ing that cap­i­tal mar­kets will do bet­ter than expect­ed is a dan­ger­ous choice.

A fore­cast­ed return of 2% on bonds might actu­al­ly be too gen­er­ous. After all, ten-year yields are only 1.49% as of June 30, 2016. More­over, should rates rise bonds could suf­fer loss­es.

The aver­age dura­tion of sev­er­al Morn­ingstar fixed income cat­e­gories is list­ed below. Should rates rise the aver­age fund in these cat­e­gories would be expect­ed to lose the fol­low­ing amounts. (Num­bers are based off of dura­tion infor­ma­tion and only take into account changes in inter­est rates. Con­vex­i­ty is not tak­en into con­sid­er­a­tion, nor are oth­er fac­tors such as a widen­ing or tight­en­ing of cred­it spreads.) 


If bonds can only deliv­er a 2% return, then equi­ties must return 12% in order to pro­duce an over­all port­fo­lio return of 8%. The table below details the lev­els of returns the 60% posi­tion in equi­ty must gen­er­ate in order to achieve dif­fer­ent lev­els of total port­fo­lio returns, assum­ing the fixed income return is locked in at 2%.

Impact on Bond Categories Given Various Fed Rate Increases | Swan Blog

If there was any remain­ing doubt that bonds won’t be able to ful­fill their tra­di­tion­al role in a port­fo­lio, I’d rec­om­mend read­ing one of Bill Gross’s recent newslet­ters. Always inter­est­ing, Gross men­tioned that in order to gen­er­ate a lev­el of return equal to the 7.5% return bonds have deliv­ered over the past 40 years, yields would need to drop to neg­a­tive 17%. In oth­er words, bonds will NOT be deliv­er­ing return sim­i­lar to its long-term aver­age over the past four decades.

At Swan Glob­al Invest­ments, we believe there is anoth­er option. We believe the tra­di­tion­al 60/40 port­fo­lio (equity/bonds) is fun­da­men­tal­ly bro­ken and needs help. Investors are caught between a rock and a hard place, as both equi­ty mar­kets and fixed income mar­kets are trad­ing at all-time highs. We believe that the Defined Risk Strat­e­gy is a bet­ter solu­tion and helps fix the prob­lems with tra­di­tion­al bal­anced port­fo­lios. The DRS com­bines volatil­i­ty cap­ture, long expo­sure to the mar­ket via ETFs, and effec­tive hedg­ing tech­niques in a sin­gle strat­e­gy designed to pro­vide con­sis­tent returns through­out ris­ing, declin­ing, or flat mar­kets with­out any depen­den­cy on fixed income or inter­est rates.

Click to learn more about Swan’s DRS invest­ment approach and how this approach has fared in the past.

For more infor­ma­tion please con­tact Swan at 970–382-8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.



Impor­tant Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non­qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains.  This analy­sis is not a guar­an­tee or indi­ca­tion of future per­for­mance. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970.382.8901 or vis­it 183-SGI-072116[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

By | 2017-08-21T15:46:06+00:00 July 21st, 2016|Blog|Comments Off on Is the 60/40 Portfolio Broken?