The '60/40 Portfolio' Is in Trouble

?Following on our discussion from yesterday... This chart - from technical analyst Willie Delwiche – caught my eye late yesterday. He shared it on Twitter...

There are a lot of lines on the chart, making it difficult to read... but the important one is highlighted - the short, thicker black line representing the performance of the 60/40 portfolio so far in 2022... in contrast to how it performed in other periods.

In the last 10 years, the traditional 60/40 stock-bond portfolio has returned an average of about 9.7% per year... Thus, many people have come to expect 10% annual returns by simply "doing nothing."

But that's not always what happens... When the markets go down, indexing really hurts passive investors, like in 2008 during the financial crisis...

Today, if the 60/40 strategy is to deliver its average return by the end of this year – or close to it – stocks and bonds have some significant making up to do. Because the allocation is already down about 5% through the first few weeks of 2022...

Now, that is better performance than if you held a basket of mostly Big Tech stocks or only growth names in your portfolio...

But "only" a 5% loss, compared to worse, is a small comfort if you're an index investor and are interested in seeing your money grow... or at the very least, don't want it to lose value.

With the markets down in general, passive investors are down too and could endure more pain... Fortunately, as I will share today, we have a few alternatives for anyone to consider... and I will explain the biggest reason why you might want to think of these options for your own investment-allocation decisions.

This is what I've been warning about...

If you've followed my posts or BLOG for any length of time, you understand that I believe that many stocks have been overvalued recently relative to their fundamentals...

A broad sell-off in stock prices hasn't been unexpected... In fact, it comes with the territory of a "juiced up" market, which is what we have had for the last year or more...or 12...

But the 40% part of the 60/40 portfolio ? the bonds... and the presumption about the "safety" of bonds ? might be even more concerning than anything that might happen with stocks...

A guaranteed way to lose money...

With inflation running high and government bonds – a bedrock of that 60/40 portfolio – yielding less than inflation, I've said more than once that bonds are 'going broke safely '.

And as I've written before, the No. 1 rule in investing is, or should be...?Don't lose money .

It sounds obvious, but by not?losing?money, you preserve the current value of your portfolio... and also set yourself up for bigger gains in the future by having more capital on hand to put into good, long-term buying opportunities when they arrive...and you help to fight the inflation monster, by having more capital available when needed.

From analyst Corey McLaughlin...

If 40% of a portfolio is dedicated to a low-return asset class that won't keep up with inflation, it's the opposite of safe. They're going to drain your retirement account and purchasing power... before the government does anything about it, if at all.

... it could take decades to earn all your principal back on a bond purchase. And it's the same story with stocks...

The S&P 500 trading at a "CAPE ratio" [cyclically adjusted price-per-earnings ("P/E"), or Shiller P/E ratio] of 38 times earnings implies it would take 38 years to earn back your purchase price in earnings.

We can't tell you exactly how stocks and bonds will perform over the next decade... No one can see the future, after all. We can only tell you what we think will happen...

...if you're expecting the same old returns from these two massive asset classes over the next decade, you might want to think again...

Specifically, inflation is here...

That means you need to consider owning other investments – things like gold, real estate, or other hard assets – more seriously than you might have in the past.

Similarly, back in early 2020, I sounded the alarm for what might be a high-inflation environment in the years ahead - and the demise of the 60/40 portfolio.

We're seeing these warnings play out today, as inflation has recently hit new year-over-year highs. The spike might not be done yet... and even it is, inflation could stay elevated in the months, years, and perhaps decade ahead.

Please, make sure you are prepared...

As we've been saying recently, it's critical that at least part of your long-term portfolio be designed specifically to protect against the "evil" effects of inflation, which directly or indirectly can take a bite out of your portfolio and hard-earned savings...

Remember that inflation is a headwind for "conventional" portfolio wisdom... and a factor we haven't seen in decades. And as we wrote last summer, just because something has worked in general for 30 years doesn't mean it will this year... or the next.

Now, don't get me wrong... Often lost in the inflation discussion is that owning stocks is actually a great way to protect yourself. But you want to own the right stocks... like shares of capital-efficient companies or in those that have the ability to increase prices and keep making profits.

And you would also be wise to consider "hard assets" that grow in relative value as the dollar becomes less valuable... But how do you know what the right mix is, if the right mix is not the 60/40 "set it and forget it" model that so many investors are using today?

To that point, we have several active alternatives to the '60/40 portfolio'...

And even better if you are strapped for time like many individual investors, none of them will require more than a few updates each year... if anything.

There are assets that won't lose money in a market sell-off, that can offer inflation protection, and can make sure you have a guaranteed income in retirement . But you won't hear about them from the 'mainstream advisors'.

It's worth considering moving beyond the 'traditional investments' of stocks, bonds, and mutual funds. Moreso today...

(h/t Corey McLaughlin)