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 Is the 60/40 Portfolio Broken?

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Challenges to the Traditional Portfolio

For decades the stan­dard rep­re­sen­ta­tion for a bal­anced port­fo­lio has been the 60/40: 60% equi­ties with 40% bonds. Although most investors are diver­si­fied beyond this mod­el with small caps, for­eign stocks, high yield bonds, and maybe even 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. This stan­dard allo­ca­tion pro­vid­ed just the right amount of risk and con­ser­v­a­tive invest­ments to reach a tar­get­ed return.


The Attraction of the 60/40

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

The tra­di­tion­al port­fo­lio has con­sis­tent­ly pro­vid­ed decent returns for the aver­age investor.

Traditional Portfolio Returns - Is the 60 40 Broken - Swan Insights

Source: Zephyr StyleAD­VI­SOR


Look­ing at the above num­bers, one might be tempt­ed to say, “If it ain’t broke, then don’t fix it.” But such an approach is dan­ger­ous­ly naïve.

This sim­ple approach may not meet these expec­ta­tions going for­ward and the main cul­prit is the 40 in the port­fo­lio: bonds.


Yield Curve

With rates at his­toric lows, the like­li­hood of bonds post­ing returns any­where near their his­toric lev­els is close to zero. Since yields and bond prices are inverse­ly relat­ed, the upside poten­tial of bonds is essen­tial­ly capped.

Yield Curve 6.30.18 - 60 40 Broken - Swan Insights

Source: U.S. Trea­sury Depart­ment

With the cur­rent yield curve, an investor pur­chas­ing 10, 20, or 30-year bonds will be hard-pressed to out­per­form infla­tion.

So what does this mean for the tra­di­tion­al 60/40 com­po­nents?


Impact of Low Yields on Portfolio Return

Low bonds yields will ask more of the equi­ties por­tion of the port­fo­lio, which may require riski­er posi­tions.

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 to lift the port­fo­lio up to 8%?

What will equities have to return - 60 40 Broken - Swan Insights

Source: Swan Glob­al Invest­ments

The answer may come as a nasty sur­prise: 12%.

Fixed Income and Forecasted Returns - 60 40 Broken - Swan Insights

A fore­cast­ed return of 2% on bonds might be too gen­er­ous. Should rates rise, bonds could suf­fer loss­es dam­ag­ing the return of the port­fo­lio.


Rising Rates means Losing Value

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.

Morningstar Category Averages - 60 40 Broken - Swan Insights

(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.)


In one of Bill Gross’s newslet­ters from a few years ago, Gross men­tions 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.


Unappealing Set of Options

Giv­en these cir­cum­stances, investors and advi­sors are left with an unap­peal­ing set of options:

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

Low­er­ing expec­ta­tions or tak­ing on more risk may not be an option for many investors and hop­ing that cap­i­tal mar­kets will do bet­ter than expect­ed is a dan­ger­ous choice.

If bonds won’t pro­vide the return stream nec­es­sary to investors, it may be time to rethink how that 40% of the port­fo­lio is allo­cat­ed.


About the Author:

Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global Investments Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Port­fo­lio Man­ag­er, 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 non-qual­i­fied 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 Swan prod­ucts uti­lize the Defined Risk Strat­e­gy (“DRS”), but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS prod­uct offer­ings will have dif­fer­ent per­for­mance results due to offer­ing dif­fer­ences and com­par­ing results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. 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. 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 www.swanglobalinvestments.com327-SGI-080818

By |2018-10-30T07:55:18+00:00August 21st, 2018|Blog|Comments Off on Is the 60/40 Portfolio Broken?