- by Mark Hulbert
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Oct. 21, 2016
CHAPEL HILL, N.C. — You might want to reduce your equity exposure now.
It’s not because a bear market is around the corner. No, it’s because an all-equity portfolio barely produces better returns than a mix of stocks and bonds. So why incur additional risk if you don’t have to?
Consider the performance of a 60/40 stock/bond portfolio over the past 90 years, assuming the bond portion is invested in intermediate-term U.S. Treasuries and is rebalanced annually. Since 1926, according to data from Ibbotson (a division of Morningstar), such a portfolio would have produced an 8.6% annualized return. That’s just 1.4 percentage points lower than the 10% annualized return of an all-stock portfolio.
There was an even smaller difference over the past 20 years: The all-equity portfolio beat the 60/40 portfolio by only 0.7 percentage point.
The question that this 60/40 portfolio’s return poses for us: Is 0.7 to 1.4 percentage points a year a big enough margin to compensate you for taking on nearly twice as much risk in an all-stock portfolio?
As you ponder that question, consider that it’s the rare investor who actually is able to stick with an all-stock portfolio during a bear market. The far more typical pattern is for equity investors to throw in the towel as losses mount.
Claude Erb, a former fixed-income and commodities manager at mutual-fund firm TCW Group, put this point vividly to me: «The people who can truly stomach the volatility of a 100% stock portfolio are either catatonic or dead.»
Some skeptics will object that the 60/40 portfolio’s past performance isn’t relevant for the future, since interest rates today are so low and bonds will lose ground when interest rates rise. But a careful analysis of the data suggests this might not be as big a worry as you would think.
That’s because there is no significant historical correlation between interest-rate levels and the relative subsequent performances of an all-equity portfolio and the 60/40 portfolio. Just consider the period from 1966 to 1981, widely considered to be the worst sustained stretch in U.S. history for bonds. During that time, the yield on intermediate-term Treasuries nearly tripled from 4.7% to 13.6%. Believe it or not, the 60/40 portfolio over that period beat the all-equity portfolio by 0.3 percentage point per year on an annualized basis.
And in the event a major equity bear market occurs in the next several years, as seems likely, the 60/40 portfolio would come out even further ahead of the all-equity portfolio.
The bottom line? For almost all investors, a 60/40 stock-bond allocation is likely to be superior to an all-equity strategy. The exception would be if you have many years until retirement or if you actually have the intestinal fortitude to stick with stocks no matter what.