Financial advisors consider the 60/40 allocation the “gold standard” investing strategy.
“Allocate 60% of your funds to stocks and 40% to bonds. This lowers your portfolio volatility without sacrificing much in the way of returns.”
This sounds reasonable. After all, diversification is a well-respected investing principle.
Fixed income (bonds) assets provide regular coupon (dividend-like) payments, which is great for retirement.
But we were skeptical…
…and as it turns out, justifiably so.
JP Morgan analyzed the annual returns for three portfolios: stocks, bonds and a 60/40 split from 1950 through the present.
It turns out the 60/40 portfolio DOESN’T reduce volatility all that much.
Oftentimes, it performs as poorly or as well as the worst or best-performing asset class.
How is that possible?
Shouldn’t one asset class act as a hedge against the other?
That’s the assumption on which this entire portfolio’s foundation is built…
…an assumption we tested…
…and it turns out if you followed this mixed investment strategy in ANY way, shape or form…
…it could be sabotaging your retirement.
Here’s why.
Breaking Down the Bond Versus Stocks Relationship
Every investment we make balances risk and reward.
Bonds are considered lower risk because they create contractual obligations for repayment.
When a company issues debt, it’s obligated to repay that debt based on whatever schedule is set. If they fail on any one payment, the bond holder can take the company to court.
During bankruptcy, bondholders are first in line when the court liquidates a company’s assets, allowing the bondholders to recover some of their principal.
However, bondholders don’t share in the company’s profits.
As owners in the company, stockholders do this so they can achieve capital appreciation.
The tradeoff is they often get wiped out when a company fails.
So, when investors want risk, they buy stocks. When they want safety, they buy bonds.
This should create an inverse relationship, where bond prices fall when stocks go up, and vice versa.
Unpacking the Truth
Correlations tell us how well two assets move together and measure them on a scale from -1 to +1:
- -1 = The two assets move in perfectly opposite directions.
- +1 = The two assets move perfectly together in the same direction.
- 0 = The two assets move completely independently of one another.
We looked at the correlation between the U.S. Treasury 20+ Year Bond Exchange Traded Fund (ETF) (NASDAQ:TLT) against the S&P 500 ETF (NYSEARCA:SPY) on a rolling 36-month basis.
From 2006 to the present, the relationship between stocks and bonds has had a slight inverse bias but largely was uncorrelated, except from 2012-2015.
In layman’s terms: stocks and bonds moved independently of one another.
Therefore, it makes sense that the 60/40 portfolio didn’t reduce volatility in most years.
Additionally, the 60/40 strategy would only benefit an investor in a year where one asset class significantly outperformed the other AND stocks and bonds were negatively correlated.
As you can imagine, that rarely happened.
What This Means For Investors
Here’s how to turn this mind-blowing insight into action.
Reevaluate any passive or static investment funds or strategies you’ve implemented.
This includes:
- Target Date Funds
- Stock/Bond Index Funds
- Stock/Bond Passive Strategy Funds (i.e., dividend growth/appreciation funds)
They don’t take advantage of stocks or bonds when they’re cheap. Plus, they lump together the good and the bad.
We advocate for a more nuanced and active approach.
For example, rather than bond funds, we advocate for evaluating and investing in individual bonds.
It makes a lot of sense to own one-year treasuries right now in some capacity since they yield 5.5%. But it wouldn’t make sense to keep owning one-year treasuries after the Fed lowers rates.
Plus, we wouldn’t advocate for owning long-term treasuries right now.
But we also aren’t a fan of just owning a broad index like the S&P 500.
There are plenty of first-rate names out there with quality earnings, cash generation and growth.
And we might have just the thing you’re looking for…
…a mystifyingly simple strategy that trounces major indexes…
The Untold Secret
Everyone from John Bogle to the Raymond James advisor down the street wants you to believe that active investing is a losing proposition.
They point out that over 80% of hedge funds underperform the market on average.
But that’s an inappropriate comparison.
We aren’t hedge funds, nor do their restrictions limit us.
In fact, Jim Woods believes any investor can outperform the market with just three stocks.
Investing doesn’t need to be a complicated venture.
As Jim will show you, a well-constructed portfolio can OUTPERFORM THE S&P 500 by as much as 1,461%.
It doesn’t require hours of homework or toiling away in front of charts.
