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CNBC ANCHOR BECKY Quick recently summed up today’s retirement investing dilemma in one sentence: “You’re never going to make enough money if you have 40% of your money in bonds.” She, along with many pundits, believe the old standby recommendation to invest 60% in stocks and 40% in bonds—the classic balanced portfolio—is dead. Google “60/40 asset allocation” and the majority of recent articles have titles that include such words as “eulogy,” “endangered,” “dead,” “the end of” and “not good enough.”
Likewise, I regularly chat about investment strategies with friends and none is rushing to buy bonds or extend maturities at today’s low interest rates. Even “bond king” Jeffrey Gundlach suggested in a December 2019 interview that “corporate bond exposure [in the U.S.] should be at an absolute minimum level right now.”
While many articles and pundits deride the old balanced portfolio, surprisingly few articles suggest a simple yet sound alternative. CNBC’s Quick inadvertently identified it when she stated, “I have some cash so that I make sure that I have a cushion… but I don’t have anything in bonds.”
Quick’s views mirror that of my friends and me, as we invest in today’s low-interest rate environment. Our approach: Maintain enough cash to weather a stock pullback, while investing the rest entirely in stocks. How much should you keep in cash? Think about how much money you need each year from your portfolio to supplement other income sources, like Social Security, pensions and income annuities.
Since the Second World War, there have been a dozen major declines of 20%-plus. From the start of these bear markets, it took an average of almost three years for share prices to return to their earlier peak, with the absolute longest taking seven-and-a-half years.
In other words, the historical data suggests retirees might hold cash equal to three years of portfolio withdrawals at a minimum and perhaps five years if they’re more conservative. Buoyed by this backup source of spending money, we then should have little to worry about if we invest the balance of our assets in a diversified stock portfolio, even though the resulting stock allocation will likely be significantly above the old 60% recommendation.
Obviously, folks still working can hold even less cash. I was 100% invested in stocks when I was in the workforce. But retirees may have to be more conservative with their cash allocation, unless they have the flexibility to generate extra spending money by, say, initiating Social Security payments, working part-time, borrowing or selling nonfinancial assets.
John Yeigh is an engineer with an MBA in finance. He retired in 2017 after 40 years in the oil industry, where he helped negotiate financial details for multi-billion-dollar international projects. His previous articles include Our To-Do List, Death and Taxes and Take a Break.
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William Bernstein, a noted investment advisor, writes
This is exactly what I’ve been doing and the first time I’ve seen anyone else recommending the same. Thank you
I am 72. I have 90% of my portfolio in dividend paying equities. Yes, the value may go down, even a lot as they did in 2000 and 2008 but after both crashes, they cam back and values increased. A lot of my portfolio is with Fidelity and when I go for a portfolio reviews, they tell me to increase my bond allocation. They even say the company will not allow them to recommend a portfolio with such a high equity allocation. But my portfolio does better than any they would recommend. I live off the dividends. Again it is true that companies such as GE have cut dividends substantially but most raise the dividend annually, usually more than inflation. And the dividend rate in many cases is above even the long term bond rates.
And intriguing theory for which I’d welcome feedback. Given the data that the average recession last ~ 15 months, and the last crash of ’09 took roughly 18 months (so, above average) to recover, what about the concept of, let’s say for comfort’s sake, a 24 month “cash cushion” to cover ongoing expenses, over which time one wouldn’t have to sell other assets at a loss. Yes, it keeps money “off the table”, but seems to me it would greatly minimize the risk of needing to sell at a loss to cover expenses.
Although major declines have typically been short-lived, it is worth noting that the Dow had a 0% return from January 1966 to October 1982.
“60/40 is dead” during the good times – and “this time it’s different” during the next crash. lol – i guess one benefit of growing older is hearing the same slogans come back around a 2nd, 3rd or 4th time.
Reality: 3-5 years in expenses won’t help retirees should the next crash cause or contribute to a prolonged depression. It’s not the plunge…it’s the slooooow recovery – it could take 8-10 years just to get back to the level you were at before the crash.
For folks with pensions or other guaranteed income sources (which the author mentioned), sure – they’re fine. But imo, not sure that heavy an allocation is wise for anyone relying primarily on their portfolio, even with SS.
There is something called sequence of return risk that can impair the ability of retirees to be able to maintain a base of retirement savings that is sufficient enough to last a full retirement. Sequence of return risk is the risk that there will be a market downturn at a time during the accumulation phase of retirement that is close to the beginning of retirement and/or soon after the retirement withdrawal phase. Just imagine if someone was a few years from or about to retire had 100% of their retirement savings in equities back in 1972, 1999, 2007. Many people do not have the wage earning ability to recover very easily from such a return shock. For serious advice on how to navigate the waters of allocation over time to better mitigate sequence of return risk read Kitces.com.
I remember having 95% in stocks and lost 70% of my portfolio in the tech bubble crash. I had that same view as the author who says he never has bonds. But never again. I love my bonds. Heck last year both my Vanguard Total Bond Market and Vanguard International bond indices returned over 8.0%. Yeah, its only one year but in the last ten years, my 30% equity/70% bonds returned 5.9%. For me well into retirement at 72, I am very happy with that return, and my extremely low cost portfolio, .07%. Costs are just as important as returns. My extremely low cost portfolio is also what is funding my retirement. Because that money is going into my pocket, not into some expensive fiduciary financial adviser.
I’ve said before I think the 60/40 portfolio is immortal. But it’s not 40% bonds, it’s 40% Fixed Income. My Fixed Income used to be 100% intermediate treasuries (I’m influenced by David Swenson). Now it is a Stable Value fund, earning about 3%, with top notch insurers behind it. When/if bond yields exceed that the SV fund, I’ll diversify.
Bonds have had long periods of negative real returns, and with rates near historic lows that could repeat. It’s been 40 years or so since those bad times, and interest rates declined from 18% or more in 1980, down to 1.5% today. Even with what appears to be heightened risk, they can be a lifesaver for a portfolio even in periods of modest bond performance, and I think there is some value for bonds due to how they perform relative to stocks (rather than just viewing them an individual asset class.) I’m just not sure how to define that value (!) Short term bonds are still a very good option, and people will have to make up their own minds regarding interest rate risk related to intermediate and long bonds.
Cash, of course. I struggle a bit with the lack of opportunity cash provides in a recession relative to Bonds, but it’s a fine alternative.
Also, gold is a respectable alternative to bonds. Look at a long term portfolio with 40% gold instead of 40% bonds. It’s not as good from a risk or a return standpoint, it doesn’t mix so well with bonds either, it has long periods of relative under-performance, (& I have intrinsic issues with gold) – but it’s not outside the realm of reasonable alternatives.