Is this the end of the traditional balanced portfolio?

The death of the balanced portfolio gets a lot of press. You’ll typically see it written as the death of the 60/40 portfolio. Should we plan the funeral for this tried and true investment approach? Or perhaps the balanced portfolio might reply that “the reports of my death are greatly exaggerated.” Is the 60/40 portfolio dead?

For those that follow the financial press, it’s hard not to come across these portfolio obituaries. I’ve certainly had questions from readers. Are we in an era where ‘the old way’ doesn’t work?

Bank of America wrote a paper that suggested that the typical 60/40 portfolio will not get the job done. They suggested that moving forward bonds may not work as well or at all as risk managers. And on US News it was reported that the 60/40 portfolio is as good as dead for the retiree. That said, in that article is was offered …

In terms of 60/40 portfolio historical returns, a portfolio composed of the S&P 500 and 10-year U.S. Treasurys has averaged a 9% return annually since 1928, according to DataTrek Research. That return shrinks to 5.9% when inflation is factored.

Those are some pretty good numbers. But are the salad days over?

Another debt crisis?

One of my readers found this scary video created by the Wall Street Journal. The video suggests that $3.7 trillion of corporate debt is going to blow things up real good. Nothing like the thought of another debt crisis to get investors riled up.

Many will write that that traditional balanced portfolio may not work because of headwinds on all sides. Bond yields are low. They simply cannot contribute to total returns in any meaningful way. US stocks have been on such a tear that they’ve run out of gas.

And of course that trend has continued from 2016 with roaring stock markets and bond yields falling further. Certainly there is the risk of entering a rising rate environment. Bonds become a drag.

It’s true. Most investors have only know the bull market for bonds that began in 1981. We would have to acknowledge that it’s no longer 1981. At the same time we have to state the obvious fact that no one knows where rates will go. No one knows the future. But ya, if we are in a lower for longer bond environment, bonds will do nothing to boost returns.

Stocks have nowhere to run?

The price to earnings ratio shows that US stocks are expensive. Investors are paying more for the current earnings.

And some will make it look even ‘scarier’ when they throw the Shiller cyclically adjusted PE ratio chart at you.

Then they can add that the only time the ratio has been this high, we’d have to look to the Great Depression and the correction of the early 2000s.

It’s true when we buy large cap US stocks these days, we’re paying more for the earnings compared to ‘normal’.

What is the 60/40 portfolio?

Most of these studies are based on that simple mix of the S&P 500 for stocks and 10 year US treasuries for bonds. But how many investors would take that simple two-legged stance? Yet it’s certainly a simple approach that would have historically, rewarded investors quite handsomely.

Canadian investors don’t invest ‘like that’. For those who’ve gone Robo, here’s how Nest Wealth clients are situated.

And here’s a Balanced Mix at the ‘Robo’ ModernAdvisor.

We see greater diversification with Canadian, US and International equities (including emerging markets), real estate, Canadian and International bonds.

The eggs are not all in the US. We have more options for growth and diversification. There are more weapons for managing risks.

This is not the first time the 60/40 portfolio has died.

I did reach out to several writers and bloggers. Could this be true, the balanced portfolio will not work moving forward? Robb Engen of Boomer and Echo offered up a link from A Wealth of Common Sense, A Eulogy for the 60/40 portfolio. Ben Carlson offered this insight and clarity.

And a US investor that also embraced some international diversification would have even greater returns with less risk. On Seeking Alpha I offered a table that suggests US investors would be well served by international stock funds. US investors might also say goodbye to their home bias. Canadian and international stocks are not nearly as expensive as US stocks.

For my wife’s account and for her Canadian equity allocation I use Vanguard’s High Dividend Yield ETF VDY. The information overview page suggests the PE ratio is 12.6. We’re buying very generous current earnings. And the earnings growth rate is almost 8%. That’s sounds like the traditional setting that DID deliver generous portfolio growth.

Stocks for growth, bonds for ballast.

That is the traditional idea of portfolio teamwork. I am not sure that we can do much to boost those prospects. Traditional core index equity funds will capitalize on economic growth and prosperity in Canada, the US and around the world. But we might add some growth kickers, by way of some mid cap or small cap funds. We might get some more out of growth oriented funds such as the tech heavy Nasdaq 100 index.

The investor is an optimist.

An investor must be a long-term optimist. He or she must believe in the prospects for long-term economic growth. The greatest investor in the world, Warren Buffett, still believes in the long term growth prospects of America. And there certainly is not a more hard-working and creative nation on earth. We have the ‘explosion’ of the middle classes around the developing world. We have global population growth.

One might argue that is all ‘not good’ for the environment. But maybe technology and innovation will come to the rescue. All told, there’s perhaps nothing to suggest that the global script has changed for the prospects for a well-balanced portfolio.

Private equity?

Many will suggest that we need some non-traditional assets. Perhaps we can manage the risks in a slightly better manner by going off-script. I’ve emailed and chatted extensively with Arthur Salzer on this subject. He is the CEO and Chief Investment Officer of the family firm Northland Wealth Management.

Northland will manage the portfolios with some options typically not accessible for the average investor. Many who suggest a new 60/40 will include private equity. That said, Arthur did pen this article for the National Post on how the retail investor might get some private equity exposure.

Private equity can remove some of the traditional public market pricing risk. Surprisingly, the Canadian investor with modest assets can access private pool funds by way of Canadian Robo Advisor WealthBar. If private equity sounds interesting that can be a route for a portion of your funds.

Here’s my WealthBar review. Get treated like you’re rich, even when you’re not.

And of course, if you have a healthy enough portfolio balance, you can team up with a firm such as Northland Wealth Management. These types of firms will also have access to private debt options and more. It will all get a little to closer to how a massive pension fund will manage assets.

Do we need a new 60/40 portfolio?

A very core couch potato portfolio might be along the lines of the Tangerine Portfolios. They simply own/replicate the developed stock markets of the world and manage the risks with Canadian bonds. That will work as well as the markets allow. There’s no reason to guess that the approach will not continue to work very well moving forward. That approach will capture and profit from global economic growth.

So the question might not be is the balanced portfolio dead. The question might be is economic growth dead. We don’t know that answer. But I’m going to remain an optimist. I will continue to be an investor.

Portfolio tweaks.

We might move beyond that core approach. You might add more exposure to Canadian and US and International real estate. You might add developing markets. Consider US and international bonds that includes developing markets. Many will suggest a modest allocation to gold and commodities. Again, you may find a way to add some private equity.

Could all of this lead to greater returns? Perhaps we are only tweaking things, even though the potential moves are many. There’s likely the opportunity for better risk-adjusted returns over a longer time period. But I’d guess that a core couch potato approach will still work moving forward. The sensible balanced portfolio is not dead.

Its death has been greatly exaggerated.

Common sense prevails. Focus on what you can control. The most important part is embracing a personal financial plan that includes an investment approach that you know you can stick to like glue.

Thanks for reading. Please fire away in the comment section.

Dale