When I see people touting the 60/40 portfolio, I kind of feel like Haley Joel Osment’s character in the Sixth Sense. But instead of seeing dead people, I see dead ideas.
You likely know what I’m talking about: a portfolio that seeks to automatically balance risk by holding 60% in stocks and 40% in bonds.
It sounds sensible enough, but history shows that people who invest by this rule have been leaving a lot of money on the table for a long time:
One quick glance at US stocks, seen here in purple through the Vanguard Total Stock Market ETF (VTI
VTI
BND
The problem is bonds, which have had about a 2.6% annualized return over the long term, and US stocks, which have had an 8.5% annualized return over the long term.
First, this should not shock anyone. Bonds are supposed to return less over the long term—after all, you invest in them to get income. But income is very valuable to many investors, so it tends to have a lower overall return over the long term. The inherently higher risk of US stocks, on the other hand, produces bigger returns.
The math here is simple: if we put $1 million in US stocks and wait a decade, we would have $5.1 million in assets, going by the historical returns above. That’s obviously a lot more than the $670,000 profit we’d get by putting that money into bonds. Clearly, a broad bond portfolio is going to wear down our profits, which is why this happens.
The 60/40 portfolio has resulted in a profit, but a profit that is smaller than the stock-only portfolio by an eye-watering $1,770,000!
By putting a heavy weighting toward bonds, we have literally left nearly $2 million on the table in a decade; the longer you devote yourself to the 60/40 portfolio, the more millions you’re missing out on.
The Liquid Alternative
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