Burton Malkiel: 60/40 is dead

[Onward]

The investor in bonds is, I think, very likely to get badly hurt by sticking with the 60/40.

A random walk down dangers in diversification

 

[Animorph]

Guess we'll find out. I'm not in bonds, but it doesn't feel that much "safer".

 

[ziggy29]

That said:

Stocks? Fragile economic recovery, concerns about the declining middle class and its ability to contribute to corporate profits, rising interest rates (which hurt stocks too), relatively high valuations... all lead to significant potential of losses.

Bonds? Higher interest rates leading to significantly lower bond prices?

Cash? Those 0.2% yields are losing badly to inflation, and lock in an inflation-adjusted negative return.

Pick your poison. It's fine to say bonds are risky now, but one way or another, *everything* is risky right now, be it due to economic risk, interest rate risk or inflation risk.

IMO there *is* no highly attractive place to invest today. Malkiel seems to be bullish on REITs as an additional, alternative asset class though.

 

[NW-Bound]

Very interesting. Thanks for posting.

Here's what Malkiel now recommends.

The updated portfolio for an investor in his or her 50s would look like:

Cash: 5 percent
Dividend growth stocks, emerging market bonds and tax-exempt bonds: 27.5 percent
REITs: 12.5 percent
Stocks: 55 percent

You use that as a starting point and move allocations up or down, depending on your age.​

I just thought about EM sovereign bonds yesterday, and have dipped my toe in that. Public debt load of EM countries is lower than that of developed ones.

 

[samclem]

IT looks like Malkiel is saying what a lot of us have been saying here: Allocating a substantial % to bonds ignores what is happening right now with government policies:

I think that allocation [Bogle's recommended "age= % in bonds" formula] is particularly wrong today because we are in an age of financial repression. ... Europe and Japan are having trouble reining in budget deficits, and we have high debt in the U.S., too. (The governments) are deliberately keeping interest rates down. Even a U.S. bond index fund is not the right thing to do, because BND [Vanguard Total Bond Market ETF] is about two-thirds government or agency bonds.
The investor in bonds is, I think, very likely to get badly hurt by sticking with the 60/40.

What does he recommend instead? For a 50 YO investor:

• Cash: 5 percent
• Dividend growth stocks, emerging market bonds and tax-exempt bonds: 27.5 percent
• REITs: 12.5 percent
• Stocks: 55 percent

You use that as a starting point and move allocations up or down, depending on your age.

 

[ziggy29]

The combination of higher interest rates and inflation that might result from current monetary policy could indeed be a double-whammy to the bond market, especially on the long-end. TIPs could resist the downward pressures caused by inflation but would still have the interest rate risk.

Stocks and cash, at least, have (in theory) the potential to mostly keep up with inflation. Bonds (except for TIPs) don't.

 

[audreyh1]

Recent studies indicate that portfolio survival improves if you start with a low stock percentage upon retirement and then allow the stock allocation to increase with age - the opposite of what we have been "trained" to do as retired investors.

There is a link to the Kitces-Pfau study somewhere......

 

[daylatedollarshort]

A GAO study has suggested retirees hold no more that 25% stocks -

"In an interview, Harlow noted that once a retiree starts taking money from their retirement accounts, the withdrawals become "path dependent." And if the success of a retirement income plan rests on whether the markets go up or down, one has to figure out how to protect oneself against that volatility, and especially against the risk of unfavorable "sequence of returns." And the best way to do that is by reducing one's overall exposure to equity to no more than 25%, he said."

Retirees Should Have More Annuities, Fewer Stocks - MarketWatch

They also recommended -

"And, Americans can avoid the risk of outliving their assets by saving more, working longer, investing wisely, delaying Social Security and buying a life annuity."

I find it interesting that they left off to me is what is the most obvious tactic - cut expenses.

 

[F4mandolin]

When I switched to Vanguard over a year ago.....I just couldn't talk myself into putting around 40% into bonds as had been recommended. A fair amount of that money has basically been cash. I have switched a little of my Total Stock to Dividend Growth, might move a little more. Also thinking about moving my TSP out of the Lifecycle funds (2020+2030). Really isn't much of the F fund (7%? or so), but have been thinking about increasing the G fund % to 40% and go 40% C and 10% each in I + S funds. At least that G fund just keeps cranking at a little over 2% lately.

 

[ziggy29]

"And, Americans can avoid the risk of outliving their assets by ... working longer,...."

A self-inflicted bullet to the head works too, and probably less painful....

 

[frayne]

Excellent point ziggy29 !

 

[Running_Man]

From the report linked I take it Burton believe's market timing does work on bonds but not stocks. Also apparently he is totally discounting the possiblity that the "government interference" that is occuring could result in deflation as opposed to inflation, which would make bonds the best performing asset class.

 

[samclem]

From the report linked I take it Burton believe's market timing does work on bonds but not stocks.

What's happening to interest rates/bond rates is not originating in the market. It is the result of deliberate government policies that are external to the market, which then get priced into the products (by the market).

If the government changes a policy (e.g. Municipal bonds will now now be subject to federal income tax at the regular income rate), it would be entirely logical for investors to re-examine the desirability of holding the affected assets.

The good news: While it may be hard/impossible to outsmart the market, it's usually no trouble at all to outsmart a policymaker.

 

[daylatedollarshort]

A self-inflicted bullet to the head works too, and probably less painful....

I wasn't necessarily recommending that part - just reporting the study results and surprise at the lack of to me what to me is the obvious solution - cut expenses (downsize / declutter / low cost of living area / simple living) to be able to live on what you will have in retirement income.

 

[NW-Bound]

Here's the inflation since 2000. Except for 2009, there was no deflation. Looking forward, it is difficult to see how it can recur.

Year	Inflation
2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1
2013	1.5 YTD

 

[MBAustin]

Interesting interview - thanks Onward.

I'm wondering why Malkiel didn't mention TIPS in the portfolio, only emerging market and tax-exempt bonds.

 

[ziggy29]

From the report linked I take it Burton believe's market timing does work on bonds but not stocks. Also apparently he is totally discounting the possiblity that the "government interference" that is occuring could result in deflation as opposed to inflation, which would make bonds the best performing asset class.

True, but QE isn't the only factor here: budget deficits are another big factor, and even in an otherwise deflationary environment, if the debt gets too large to be payable with current dollars, inflating the currency ultimately has to be considered (since outright default isn't a realistic or desirable option).

 

[daylatedollarshort]

Here's the inflation since 2000. Except for 2009, there was no deflation. Looking forward, it is difficult to see how it can recur.

Year Inflation
2000 3.4
2001 2.8
2002 1.6
2003 2.3
2004 2.7
2005 3.4
2006 3.2
2007 2.8
2008 3.8
2009 -0.4
2010 1.6
2011 3.2
2012 2.1
2013 1.5 YTD

Going forward economists have the benefit of hindsight as to what caused the inflation of the past so we might not see those crazy numbers again.

At my first job I think I got a 20% raise the first year just to keep my salary above what they were paying the new college hires.

 

[Midpack]

Very interesting. Thanks for posting.

Here's what Malkiel now recommends.

The updated portfolio for an investor in his or her 50s would look like:

Cash: 5 percent
Dividend growth stocks, emerging market bonds and tax-exempt bonds: 27.5 percent
REITs: 12.5 percent
Stocks: 55 percent

You use that as a starting point and move allocations up or down, depending on your age.​

I just thought about EM sovereign bonds yesterday, and have dipped my toe in that. Public debt load of EM countries is lower than that of developed ones.

No matter how you spin it, he's in essence saying increase your stock allocation (w dividend growth stocks) and put your (now reduced by some unknown amount) TBM into emerging market bonds (no risks there?) and tax-exempt bonds. IOW, he's saying change your AA to favor stocks, without being direct. Of course higher stock allocation (historically) provides a greater return, but risk increases as well...would be nice for folks recommending bond fund alternatives acknowledge risk too.

Though bond funds seem unlikely to provide a real return in the mid/long term ahead of us, stocks are still subject to more volatility - even high quality dividend growth stocks.

And short of a gripping tease, what does "downright dangerous" and "badly hurt" mean quantitatively (and relative to stocks) for those who take a long view holding TBM and the like? You mean stock allocations couldn't be "downright dangerous" or stock investors couldn't be "badly hurt?"

Don't get me wrong, I am as uneasy with my bond fund holdings as anyone, and cash may outperform bond funds in real terms for a while. But there's no safe place to be right now as Ziggy summarized above. You pick your poison(s) and spread your exposure...

Another online 'sound bite' from a few years ago http://www.cbsnews.com/news/burton-malkiels-non-random-walk-down-wall-street/

 

[ziggy29]

No matter how you spin it, isn't he in essence saying increase your stock allocation (w dividend growth stocks) and put your (now reduced by some unknown amount) TBM into emerging market bonds and tax-exempt bonds?

REITs are a form of equities, albeit with less correlation than with most other equity asset classes, so it looks like he is advocating a very high percentage of equities for someone in their 50s.

I don't really understand his fetish for tax-exempt bonds in particular, though. Not that these are bad, but they have the same interest rate risk and inflation risk as corporates and Treasuries, do they not? Emerging market bonds, at least, have some additional "play" on foreign interest rates, currency rates and potential for appreciation through improving credit risk. (That said, these are also additional risks!)

 

[Onward]

As indebted as I am to Malkiel as one of the chief enablers of my FIRE, the portfolio he recommends is ... much to hairy for me.

He's replaced the ballast in a portfolio with more stocks and emerging-market debt. No thanks.

The outlook for U.S bonds may be questionable, but, historically, a fierce bear market in bonds is a single-digit annual loss.

Compare that to stocks and EM debt?

 

[galeno]

Malkiel (and everybody else including yours truly) is basically telling investors that the 30 year bond party is over and to push your equity risk tolerance to the max.

I like to follow two rules of thumb regarding asset allocation. In a normal market, where good quality intermediate bonds can deliver a 2% real return, we are "moderate" investors.

Rule 1: A conservative investor should have his age in fixed income. Moderate investor age-10. Aggressive investor age -20. Since all good quality short to intermediate fixed income is so expensive, I allow our port to go from moderate to aggressive.

Rule 2: Fixed income allocation = annual SWR X 10. E.g. SWR = 3% FI = 30% etc.

Our port: 65% equities + 35% FI. Age = 56. Gross AWR = 3.50%. TER = 0.76%. Term = 39 years.

 

[pb4uski]

Malkiel (and everybody else including yours truly) is basically telling investors that the 30 year bond party is over and to push your equity risk tolerance to the max.

I like to follow two rules of thumb regarding asset allocation. In a normal market, where good quality intermediate bonds can deliver a 2% real return, we are "moderate" investors.

Rule 1: A conservative investor should have his age in fixed income. Moderate investor age-10. Aggressive investor age -20. Since all good quality short to intermediate fixed income is so expensive, I allow our port to go from moderate to aggressive.

Rule 2: Fixed income allocation = annual SWR X 10. E.g. SWR = 3% FI = 3% ext.

Our port: 65% equities + 35% FI. Age = 56. Gross AWR = 3.50%. TER = 0.76%. Term = 39 years.

I'm very similar. 60/40, age 58, WR ~3.3%. I'm planning to live to 100.
What is TER? ER? My weighted average ER is ~20bps.

On the bond side, I'm transitioning to CDs (in process of buying PenFed 2% 3 year) and target maturity bond funds from BND to reduce/mitigate interest rate risk.

 

[samclem]

Of course higher stock allocation (historically) provides a greater return, but risk increases as well...would be nice for folks recommending bond fund alternatives acknowledge risk too.

Though bond funds seem unlikely to provide a real return in the mid/long term ahead of us, stocks are still subject to more volatility - even high quality dividend growth stocks.

(Bold added). I think it is generally a mistake to use "risk" and "volatility" interchangeably (I do it too, and I know it is accepted shorthand in the "biz"). Stocks do have higher volatility, but if we are worried about staying ahead of inflation over the long haul and producing enough return to retire starting with a "pot" less than 50x annual spending, then a broad portfolio of stocks has less risk (of the we kind should care about) than a portfolio of 80% bonds.

 

[ziggy29]

(Bold added). I think it is generally a mistake to use "risk" and "volatility" interchangeable (I do it too, and I know it is accepted shorthand in the "biz"). Stocks do have higher volatility, but if we are worried about staying ahead of inflation over the long haul and producing enough return to retire starting with a "pot" less than 50x annual spending, then a broad portfolio of stocks has less risk (of the the we should care about) than a portfolio of 80% bonds.

That's the thing. Cash has "risk" too -- the risk of inflation and after-tax returns not keeping up with inflation (let alone growing).

Volatility breeds risk, but not all risks create volatility.