Home » News

Portfolio Construction’s Uncertain Ways Forward

A series of arrows pointing in different directions. Represents the uncertain future of financial portfolio construction.

Originally sent to newsletter subscribers on November 27th.

The 60/40 Portfolio’s Horrible, No-Good Year

What does a safe, well-balanced portfolio look like?

One of the most common pieces of “general wisdom” has been a 60% allocation to stocks and a 40% allocation to bonds. The thinking behind this is that the majority allocation to stocks still allows for strong appreciation over time. The volatility and risk of the stock market is then offset by a minority, but still heavy, allocation to bonds.

For the recent past, this seems to have performed as advertised. From 1995 to mid 2021, the 60/40 portfolio delivered only ~6.5% lower performance than a reference all stock portfolio, but with ~40% lower volatility.

Then 2022 came. Under the pressure of inflation and a rapid rise in interest rates, Old Reliable failed spectacularly. The 60/40 portfolio turned in the worst performance in 85 years.

In one of the most uncertain and volatile times in recent years, bonds failed to provide equity investors with protection and diversification when they needed it the most.

New Research, New Challenges

Why did bonds fail investors in 2022? Well, three finance professors’ new research has a bold explanation. Bonds are basically just worthless to the average long-term investor. Before reaching this conclusion, professors Anarkulova, Cederburg, and O’Doherty analyzed 133 years of financial history and data.

The main issue is inflation. Bonds provide safe nominal returns, but inflation-adjusted earnings are often quite poor.

Instead, they argue a portfolio of 50% US and 50% international stocks performs better and provides less inflation-adjusted risk overall. Interestingly, they argue that owners of US stocks are actually better off using international bonds to diversify.

Mainstream, Full Steam?

Some of you might be thinking stocks and bonds…🥱… where are the alts?

Well, it’s all connected with some big potential implications over the coming years and decades. Given this backdrop, it’s perhaps unsurprising that a recent survey from Retirement Living found strong interest in alternatives.

There’s a variety of findings from the survey, but we’ll break down a few that stand out:

  • 63% of people are hesitant to make traditional investments right now, due to concerns about the economy (and presumably inflation)
  • 43% of millennials had made an alternative investment in the past 6 months
  • 25% of respondents reported an increased interest in alternatives after the failure of Silicon Valley Bank (SVB)
  • The alternative people trust most is precious metals (gold and silver)
  • Collectibles and wine were the least trusted (even less than crypto)

Does Any Of This Matter?

Maybe. While some people will just stick with what they know, the traditional approaches to portfolio construction are facing challenges. That’s true in practice and in theory.

Investors are taking notice. Interest in alternatives is rising at the same time opportunities are increasingly becoming accessible. While only time will tell how this all plays out, it seems there is a plausible future where allocation to alternatives becomes a mainstream portfolio strategy.

author avatar
Josh Heier
Studied and working in the computer networking field. Interested in technology, finance, investing, and learning new things. Smalltime Angel Investor.