The so-called balanced portfolio, mixing higher-volatility stocks and 'safer' bonds, is the bedrock behind most portfolio management. But it could leave you broke.
If I suggested that you hand your grandmother's retirement savings over to a cardshark in the hope that he might gamble with them on a riverboat casino, you would probably give me a very funny look.
But grandma's savings are being gambled right under her nose. And there's a good chance she doesn't have a clue it's happening.
Your grandma -- like most investors -- is likely being told by the Wall Street marketing machine that some variant on the "60/40" portfolio of stocks and bonds will see her safely through her golden years. The so-called balanced portfolio, mixing higher-volatility stocks and "safer" bonds, is the bedrock behind most portfolio management. It underpins the "life cycle" and "target date" funds that Wall Street is busy selling to all the baby boomers heading into retirement. As you get older, you are supposed to hold fewer stocks and more bonds, to reduce volatility, in a "glide path" to retirement. But the fundamental principle—that balancing stocks with bonds will help you navigate all environments—doesn't change.
I've been banging on for some time about the flawed logic behind this idea. I've noted that a balanced portfolio of stocks and bonds has failed investors miserably in the past and may do so again. Such portfolios lost money, when adjusted for inflation, in the 1940s and again in the 1970s. Stocks and bonds have only "balanced" one another when one or the other was undervalued. In 1982 both were undervalued, so investors have done very well since then. Today, however, both are almost certainly overvalued. Investors are taking a huge risk.
I hadn't realized how big that risk was until a chance meeting this week with Mark Hanus, who has just launched an independent mutual fund designed to hedge inflation risk, the Inflation Hedges Strategy Fund (INHIX). Hanus used to be at Wellington, the blue-chip Boston fund company. Before that he was a co-founder of Absolute Investment Advisers.
In the course of our conversation I looked through some investment slides which Hanus had prepared. And one struck me so hard I did a double-take.
I've missed a trick. Yes, I've already reported that "balanced" portfolios have served older investors very badly at stages in the past. But I hadn't included an additional factor -- the cost of the withdrawals those investors had to make each year.
If you held money in a portfolio of 60% stocks and 40% bonds starting in 1966 -- a year when stocks and bonds were both high-priced -- and rebalanced once a year, over the following 15 years your portfolio lost about two-thirds of its purchasing power. (So much for "safe.")
But what about if you had just retired, and you had to withdraw some money from that portfolio every year to live on?
If you withdrew 5% of the portfolio in the first year, and just increased your withdrawals each year to keep pace with inflation, something alarming happened. Within about 18 years your entire portfolio was gone. Kaput.
What killed the portfolios was rising inflation -- coupled with poor returns from both stocks and bonds.
To check the numbers, I went home and built my own spreadsheet, using returns for stocks and bonds compiled by NYU's Stern School of Business, and inflation data from the U.S. Labor Department. Result? Hanus was spot on. The portfolio was gone by 1984.
What's more, the higher the percentage of bonds you held, the sooner the money ran out.
It is yet another piece of bad news in the national retirement crisis. Many Americans are retiring with less than $25,000 in savings. They are going to need "winning" portfolios if they are to have any decent chance of a dignified old age. But right now, with bond and stock markets so high, there is every chance that the best they can hope for from here is a portfolio that doesn't lose too badly.
Gulp.
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