Jeremy Siegel, the Wharton professor most famous for writing the investment classic Stocks for the Long Run, recently claimed the following:
“We believe that the old 60/40 model just won’t be able to cut it anymore,” Siegel told CNBC.
As long as U.S. government bonds remain at very low yields, the amount of income you receive from bonds will disappoint, Siegel argued. “This environment of low interest rates is not going to change,” he said.
So let’s back up a step. What is the 60/40 portfolio model and why was it considered effective in the first place?
The 60/40 argument, simply enough, was that investors who held 60% of their savings in stocks and 40 percent in bonds outperformed other potential portfolios over time.
The reason, according to proponents of the approach, is that the mix of stocks and bonds allowed for stocks to provide growth while bonds provided reinvested income and stability.
The argument was that the return was less volatile to a portfolio that was heavier with stocks while providing most of the growth necessary to offset the sleepier bond portion of the portfolio.
A portfolio that provided a steadier, compounding return with less risk was superior to a portfolio that was, say, 90 percent in stocks but prone to serious losses in a real downturn, such as 2008.
Siegel is a stock bull for sure. But his argument here is that bonds are destined to provide less oomph than in years past.
When yields fall, bond prices go up. Bond prices increases helps a portfolio grow, but it also increases the risk of a decline in bond valuations in the future. If yields are very low, there’s less upside for bond prices and more risk of a reversal.
Consequently, Siegel maintains, investors would be better off recognizing the change in the investment environment and accepting more stocks. For instance, he recommends a 75/25 stock-to-bond mix.
It’s very hard to say that Siegel is wrong. However, your exact mix of stocks to bonds often has more to do with your personal level of risk tolerance than the potential gains to be made in the coming years.
For instance, a person nearing retirement age might be very uncomfortable with the idea of owning more stocks. Meanwhile, a person under age 30 with decades of investing ahead might prefer to own even more stocks.
If you have other assets, too, it’s important to consider what your portfolio is expected to do and for whom.
Is the money truly destined for your use, or for children or grandchildren? Do you have a separate, guaranteed income, such as a pension, Social Security or both? What are your actual spending needs now and in 10 years? Do you have a mortgage? Medical spending ahead?
Coming up with the correct mix of risk and stability in an investment portfolio thus should be a holistic discussion, potentially with the help of a financial planner and tax adviser.
While academic research does have a place in suggesting a sustainable investment approach, the devil is definitely in the details. Seek qualified guidance before making any substantive changes to your own investment goals and planning.
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