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The death of 60/40 Portfolios:
Navigating the Decade Ahead
13 Years of Incredible Returns
For the past 13 years, investors have been the beneficiaries of an incredible run in the U.S. stock market. The S&P 500 Total Return index finished 10 of the past 13 years above 11%! Even in an arguably tough economic environment over the last 3 years, the index has averaged over 26% per year.
Header | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
S&P 500 | 26.5% | 15.1% | 2.1% | 16.0% | 32.4% | 13.7% | 1.4% | 12.0% | 21.8% | (4.4)% | 31.45% | 18.4% | 28.7% |
The traditional 60% stock and a 40% bond (60/40) portfolio has helped investors meet or exceed their financial goals over the past decade. While the bond allocation has not been a large driver of returns, it has served an important purpose to investors. Using bonds as a diversifier to stocks helped to de-risk the portfolio and, in the falling rate environment we've seen over the last decade, was still additive to a portfolio returns. This has been the best of all worlds from an investing standpoint!
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It's hard to believe but investors still could have done better...
Most advisors tweak the standard 60/40 portfolio to make it their own and customize it for their clients. This may include adjusting the asset class weighting, adding international, stocks, real estate, or commodities, or tilting factor exposures. Advisors use an endless number of combinations in the hopes of driving better performance; wanting the same or better returns with less risk.
Notably, to lower the overall risk of a portfolio, advisors seek diversification across asset classes and geographies. Yet, a very easy but often overlooked diversification tool that can provide tremendous portfolio benefits is diversification across the types of investment strategies being used. MSCM's Advisors prefer tactical investment strategies for this type of diversification. Tactical strategies are those that do not keep the asset class weighting constant over time and can fluctuate from being 100% invested in stocks to being 0% invested in stocks (i.e., fully defensive).
Diversifying your portfolio with Tactical Investment Strategies
Traditional 60/40 Allocation
60/40 Allocation with 30% moved to MSCM’s TPSR
Below is a comparison of a traditional 60/40 portfolio alongside a similar portfolio that adds a 30% allocation to our TPSR tactical strategy. Note that the TPSR allocation can come from the entire existing portfolio, not just the stocks allocation, because tactical strategies generally have risk profiles better than existing 60/40 portfolios; historically TPSR has reduced drawdowns and improved returns (more on this below).
All multi-year periods improved by adding an allocation to tactical
Growth of $100k since 2004
Periodic Total Returns
Additionally, all risk metrics improve by adding a tactical allocation in your portfolio. This creates a safer, higher returning portfolio. Unique diversifiers that can improve returns AND lessen risk are generally either very hard to find or too expensive to use in a portfolio for most clients…TPSR changes that for MSCM's clients.
Shockingly Low Future Expected Returns
The last 13 years have been great, but let’s look at what is ahead. Unfortunately, most major financial institutions are calling for much more subdued returns going forward. The surprising figures below are taken from the capital market assumptions of the constituent institutions. For context, the S&P 500 has averaged 16.3% since 2009 and is now expected to return at the very best 7% annually.
Capital Market Assumptions by Institution - Forward-looking 10 Year Average Return
Institution | U.S. Equities | U.S. Aggregate Bonds |
|---|---|---|
Vanguard¹ | 2.3%-4.3% | 1.4%-2.4% |
Blackrock² | 6.7% | 1.6% |
BNY Mellon³ | 5.9% | 1.2% |
JP Morgan⁴ | 4.1% | 2.8% |
Research Affiliates⁵ | 4.3% | 2.1% |
Invesco⁶ | 7.0% | 1.9% |
Average | 5.21% | 1.92% |
The unwritten presumption in these projections is that the next decade will include at least one big bear market. Think about it. To accomplish JP Morgan’s 4.1% projected annualized equity return, it is highly unlikely that the U.S. stock market returns 4.1% for each of the next 10 years. We will surely have years with great returns, years with ok returns, and years with terrible returns. The year (or years) of terrible return is what causes the average to be so low.
If these projections are remotely correct, reaching your retirement goals with a 60/40 portfolio will become significantly harder if not impossible. A tactical strategy, like TPSR, will likely help capture the gains of the great bull markets and attempt to sidestep the losses of the upcoming big bear market.
We suggest that all investors add an allocation to TPSR to their portfolio. We want to make sure clients are positioned correctly for the road ahead. Even if the prognosticators are wrong about future returns, our evidence suggests that using TPSR should still enhance the risk-return profile of your portfolio.
McElhenny Sheffield has extensive successful direct investment management experience. The firm has the ability to offer individuals and institutions sophisticated investment strategies and wealth management solutions appropriate for complex and changing market environments. This ability to adapt to fast-changing markets and to meet the evolving needs of clients has been a hallmark of our organization since 2000. Our independent, disciplined, clearly defined, rules-based investment philosophy helps drive our achievement of the competitive returns we seek for our clients.
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Send us a message with your questions.
¹
Market perspectives: December 2021 (vanguard.com)
²
Capital Market Assumptions | BlackRock
³
Our 2022 Capital Market Assumptions | BNY Mellon Wealth Management
⁴ Long-Term Capital Market Assumptions | J.P. Morgan Asset Management (jpmorgan.com)
⁵
Asset Allocation Interactive (researchaffiliates.com)
⁶ invesco-capital-market-assumption-2022-usd.pdf
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Investing involves risk. Principal loss is possible.
There can be no assurance that an investment mix will lead to the expected results shown or perform in any predictable manner. It should not be assumed that investors will experience returns in the future, if any, comparable to those shown, or that any or all of MSCM’s clients experienced such returns. No representation is being made that any account will or is likely to achieve results similar to those shown. Individual client results could significantly differ from the performance results being presented. Differences in account size, risk tolerance, timing of transactions and market conditions prevailing at the time of investment could lead to different results, and clients could potentially lose money.
If an indicator or stop levels fail to detect significant downturns in the market, the strategies will continue to be exposed to underlying positions that could potentially lose value during such downward periods. Similarly, if the indicators fail to timely identify a reversal of a downward trending market, the strategies will continue to be exposed to defensive ETFs at a time when there is significant appreciation in the equity markets. Either scenario could result in a strategy underperforming other investments that do not employ these strategies. There can be no guarantee our strategies will correctly or timely identify the industries, sectors, or asset classes that will outperform during a given quarter or that the strategies will correctly or timely identify market trends.
The strategies invest in other ETFs which will result in higher and duplicative expenses. If the strategy invests in U.S. Dollar ETFs, changes in currency exchange rates and relative value of non-U.S. currencies will affect the value of the investment. Investments in fixed income securities typically decrease in value when interest rates rise. If interest rates fall, certain obligations could be paid off more quickly and the proceeds invested in securities with lower yields. Changes in an issuer’s credit rating or the market’s perception of an issuer’s creditworthiness could also affect the value of an investment in an issuer.
Investing in ETFs are subject to risks that the market price of the shares could trade at a discount to its net asset value (“NAV”), an active secondary trading market could potentially not develop or be maintained, or trading could be halted by the exchange in which they trade, which could impact our ability to sell shares of an ETF.