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Today Morningstar released a very interesting article exploring how a 60/40 portfolio diversification limits losses during market declines. Of note is the fact that due to the 2022 bond market swoon this portfolio has still not fully recovered.
You can read the article here:
150 Years of Stock and Bond Market Crashes: How the 60/40 Portfolio Held Up | Morningstar
Here are some highlights:
There have been 19 bear markets for stocks and three bear markets for bonds over the past 150 years—that is, periods in which these investments’ value has declined by 20% or more. This has translated into 11 bear markets for a 60/40 portfolio.
To assess the level of pain experienced in each market crash, we use a framework Kaplan calls the “pain index.” This framework considers both the depth of each market decline, as well as how long it took to get back to the prior level of cumulative value.
The 60/40 portfolio experienced less pain than the stock market during nearly every market crash of the past 150 years.
The Great Depression was 4 times more painful for the stock market than for a 60/40 portfolio. The Lost Decade, the longest period on this chart, was more than 7 times as painful for the stock market.
Though their total losses during 2020 were minor, bonds remained underwater through 2021 and had a particularly bad 2022—the one year in our whole 150-year period in which bonds didn’t provide any diversification benefit during a market downturn. Taken together, the 60/40 portfolio declined 25.1% in 2022.
“Interestingly, there was only one period that saw more pain for the 60/40 portfolio than for the stock market—the period we’re in now.” That’s one way to sum up this post-mortem.
One may recall that there were articles about the “death” of the 60/40 portfolio and the merits of the 75/25 portfolio. It seems they were correct but for the wrong reasons; very few anticipated a bond bear market.
Back in 2020-2021 I was one of those advocating caution about bond funds. It was my opinion that investors were not being sufficiently compensated for the risk they were taking, no matter how slight. I acted on this and shifted largely out of bond funds, but kept small amounts of TIPS and a few corporate bond funds. Instead, I went to cash and to holding individual treasuries.
At the time this led to an interesting conversation with a financial advisor and it was his opinion this was “market timing”. Of course, when investments tank and there is some sort of a flight to safety that too is market timing. Ultimately, my argument was simple: It is my money and it is my decision; I prefer to prepare rather than to react. I do take annual withdrawals and hold more than 3 years of cash or equivalents so I don’t have to sell in a down market. Some experts say 3 years is the minimum. By holding more am I anticipating longer bear markets, say 5+ years? Yes, and that too could be construed to be a form of market timing. Is there a consequence? Yes, if we assume the market returns 8% annually and bonds/cash return half of that.
As expected, since 2020 my portfolio has lagged the S&P500. No surprise considering it is not an all-stock portfolio. A 60/40 portfolio in a situation where annual gains of 8%/4% are posted will lag about 1.6% each year. Then there are withdrawals which further depress gains.
My experience mirrors that in the article. Yes, I did experience the dot-com bust and the “lost decade”. I also experienced that other lost decade which commenced in 1972, “Black Monday” and the inflationary bear market that commenced in 1968. I was employed in capital intensive industries and there were more than a few personal recessions.
Conclusions I reached included that these things do occur with some regularity and there are many, many ways to get burned. What we can do is take steps to limit the damage, keep our emotions and our greed in check. This may be more difficult than it seems.
How did this most recent hiccup turn out for me? (I’m ignoring the recent Trump panic, which I consider to have been largely self-inflicted by investors). The only losses I experienced were in those few bond funds I own. They had a negative 0.4% impact on my portfolio. The few bond funds I own have recovered, but those potential gains were not realized. Like the price of eggs, the losses were as real as the increase in my grocery bill. Money spent (or lost) is gone forever.
My spouse owns target date and balanced index funds. The bond losses were hidden in those wrappers. Considering her aversion to paper losses, that’s a good thing.
Today, after 7 years of withdrawals we are only 0.8% off of the portfolio all-time high, as measured over a 30 year period. More importantly, the goals I set are being met. That is what really matters. Politicians and investors will do what they do and there will always be market perturbations. Currently tariff talk is all the rage. Next month? Who knows.