The "Balanced" (60/40?) Investor: Topic for Discussion & Analysis | New Thread

MaxiRobriguez

Linton said:

MaxiRobriguez said:

Linton said:

I dont see how one can possibly come up with an equity/non equity strategy unless one's objectives are clear.  What an economic guru said 40 years ago in different economic circumstances is in my view irrelevent unless one can read the objectives the guru was trying to satisfy and the arguments that led to his conclusion.  The mere fact that he said something, or is said to have said something, is not really very helpful.

On specific objectives:
1) Short term expenditure: Known expenditure in the next say 5 years that isnt covered by guaranteed income should be in cash. No question in my mind.
2) Medium term expenditure: in the medium/long term cash is not risk-free because of inflation.  On the other hand at the moment I know of no completely satisfactory investment that can meet the need for moderate but low risk returns. I use Wealth Preservation funds where I hope the fund managers with a proven record can do what I can't, or at least can't without spending detailed management time.  Smoothing investments like With Profits Funds could also play a part here.
3) Long term comfort blanket, the objective being to ensure that investors don't lose sleep during a crash with the danger that they convince themselves to sell out.   I am with Malthuisian here.  This is mainly a problem for relatively inexperienced investors who could well look at their equity investments separately.  A good answer would seem to be to use multi-asset funds at an appropriate risk level as one would naturally look at the fund as a whole.  If one doesnt have the knowledge to do a job properly it is best to pay a professional.
4) Income: if one wants ongoing income (whether one should is not an argument for here) then diversification away from equity really is very advisable.  I use corporate bond funds, funds which make loans to infrastructure projects and anything else I can find.

There may be other objectives eg a relatively small amount of non equity may be desirable for long term rebalancing.  But only when one has identified them can an appropriate strategy be devised.

The "typical 60/40" portfolio supposedly reduces volatility and concentration risk whilst still allowing reasonable gains.

It's not that hard to replicate those end goals by replacing bonds with a cash allocation in a time of low interest rates and where the threat of inflation could lead to sell offs in both equities and bonds.

It doesn't have to be more complicated than that. 

Why would you want to reduce volatility whilst allowing reasonable gains?  Different reasons for wanting to do this will lead to different ways of doing it.  For example a young long term investor may want this because they are afraid of losing all their money.  An experienced retired investor may want to protect future income in the short and medium term. There is not one single answer that optimally solves all problems.  An experiemced investor could work something out themselves.  An inexperienced investor would in my view be better off with a multi-asset fund.

It doesn't matter.

People picked up 60/40's in the past despite having a range of investing desires - ultimately they were using the bonds as a hedge against the equity element. That's probably not as appropriate as it was given where the world is now, and the llikelihood of inflation being greater than deflation I would guess.

I agree that there's different investigating strategies on offer - a 100% equity portfolio wiith some decent defensives might be better than cash. Likewise a multi-asset fund may better. I'm not saying everyone should have an equity/cash portfolio, but that people who currently have, or are thinking about buying, a traditional 60/40 equity/bond fund based on what it *used* to offer may find that an equity/cash portfolio will actually perform more in line with historic 60/40 returns than a 60/40 will going forward.

Linton

MaxiRobriguez said:

Linton said:

MaxiRobriguez said:

Linton said:

I dont see how one can possibly come up with an equity/non equity strategy unless one's objectives are clear.  What an economic guru said 40 years ago in different economic circumstances is in my view irrelevent unless one can read the objectives the guru was trying to satisfy and the arguments that led to his conclusion.  The mere fact that he said something, or is said to have said something, is not really very helpful.

On specific objectives:
1) Short term expenditure: Known expenditure in the next say 5 years that isnt covered by guaranteed income should be in cash. No question in my mind.
2) Medium term expenditure: in the medium/long term cash is not risk-free because of inflation.  On the other hand at the moment I know of no completely satisfactory investment that can meet the need for moderate but low risk returns. I use Wealth Preservation funds where I hope the fund managers with a proven record can do what I can't, or at least can't without spending detailed management time.  Smoothing investments like With Profits Funds could also play a part here.
3) Long term comfort blanket, the objective being to ensure that investors don't lose sleep during a crash with the danger that they convince themselves to sell out.   I am with Malthuisian here.  This is mainly a problem for relatively inexperienced investors who could well look at their equity investments separately.  A good answer would seem to be to use multi-asset funds at an appropriate risk level as one would naturally look at the fund as a whole.  If one doesnt have the knowledge to do a job properly it is best to pay a professional.
4) Income: if one wants ongoing income (whether one should is not an argument for here) then diversification away from equity really is very advisable.  I use corporate bond funds, funds which make loans to infrastructure projects and anything else I can find.

There may be other objectives eg a relatively small amount of non equity may be desirable for long term rebalancing.  But only when one has identified them can an appropriate strategy be devised.

The "typical 60/40" portfolio supposedly reduces volatility and concentration risk whilst still allowing reasonable gains.

It's not that hard to replicate those end goals by replacing bonds with a cash allocation in a time of low interest rates and where the threat of inflation could lead to sell offs in both equities and bonds.

It doesn't have to be more complicated than that. 

Why would you want to reduce volatility whilst allowing reasonable gains?  Different reasons for wanting to do this will lead to different ways of doing it.  For example a young long term investor may want this because they are afraid of losing all their money.  An experienced retired investor may want to protect future income in the short and medium term. There is not one single answer that optimally solves all problems.  An experiemced investor could work something out themselves.  An inexperienced investor would in my view be better off with a multi-asset fund.

It doesn't matter.

People picked up 60/40's in the past despite having a range of investing desires - ultimately they were using the bonds as a hedge against the equity element. That's probably not as appropriate as it was given where the world is now, and the llikelihood of inflation being greater than deflation I would guess.

I agree that there's different investigating strategies on offer - a 100% equity portfolio wiith some decent defensives might be better than cash. Likewise a multi-asset fund may better. I'm not saying everyone should have an equity/cash portfolio, but that people who currently have, or are thinking about buying, a traditional 60/40 equity/bond fund based on what it *used* to offer may find that an equity/cash portfolio will actually perform more in line with historic 60/40 returns than a 60/40 will going forward.

60:40 equity/bonds is a moderately safe rule of thumb that people can use with very little thought.   But it is a rule of thumb and as such it does not pay to question the details too much as the whole  basis may look shakey.

I agree that in current circumstances cash is a better option than safe bonds.  However it does not perform in line with traditional bonds which even in the worst times generated a useful return.  There are no investments that behave like traditional bonds. So one has to compromise.   To know where to compromise one must know what benefits are important.

Prism

Linton said:

2) Medium term expenditure: in the medium/long term cash is not risk-free because of inflation.  On the other hand at the moment I know of no completely satisfactory investment that can meet the need for moderate but low risk returns. I use Wealth Preservation funds where I hope the fund managers with a proven record can do what I can't, or at least can't without spending detailed management time.  Smoothing investments like With Profits Funds could also play a part here.

This is the bit I am still to decide on. I could go it alone and use a combination of cash, short/medium duration bonds, index linked bonds and gold to make up this allocation - the bit in the original simple model which was 40% bonds. Or I could use a reliable wealth preservation fund or two and then reduce my equity allocation by a certain amount as many of those wealth preservation funds include a good chunk of equities too. My main worry with that is that the fund managers make significant allocation changes without me spotting it which would require me to adjust my own equity pot to stay in balance. I guess what I really need is a wealth preservation fund that doesn't contain equities.. I guess thats a strategic bonds fund.

Linton

Prism said:

Linton said:

2) Medium term expenditure: in the medium/long term cash is not risk-free because of inflation.  On the other hand at the moment I know of no completely satisfactory investment that can meet the need for moderate but low risk returns. I use Wealth Preservation funds where I hope the fund managers with a proven record can do what I can't, or at least can't without spending detailed management time.  Smoothing investments like With Profits Funds could also play a part here.

This is the bit I am still to decide on. I could go it alone and use a combination of cash, short/medium duration bonds, index linked bonds and gold to make up this allocation - the bit in the original simple model which was 40% bonds. Or I could use a reliable wealth preservation fund or two and then reduce my equity allocation by a certain amount as many of those wealth preservation funds include a good chunk of equities too. My main worry with that is that the fund managers make significant allocation changes without me spotting it which would require me to adjust my own equity pot to stay in balance. I guess what I really need is a wealth preservation fund that doesn't contain equities.. I guess thats a strategic bonds fund.

I hold Jupiter Strategic Bonds in the WP portfolio and have had no cause to consider changing it.

Whether you need to change your growth investments to take account of the WP funds is perhaps open to question.  An advantage of my 3 portfolio approach is that each one can be assessed on its own merits.  Though I do have a spreadsheet which combines the allocations of all 3 portfolios to check for too much commonality or overall gaps.

 My WP portfolio is 70% the size of the Growth portfolio and is only 27% equity.  So the effect on the overall allocation is limited.  However it does help balance the Value vs Growth split.  One would not expect this to change much.

tigerspill

Linton said:

minimum required to meet objectives with high diversification
Income: 10
WP: 3
Growth: 8

Could I ask if you would be prepared to list your funds here?

Thrugelmir

At the outset when the 60/40 portfolio was born. UK Government Gilts ( and US Investors Treasury Stock etc) offered above inflation rates of return, i.e. positive yields. They no longer do.  Cash doesn't provide the solution now. So requires equities to perform even more of the heavy lifting to compensate. Not a comfortable position to be skewed towards equities given the elevated valuation of many companies already, and the fact that there's an entire generation who'll need to sell these investments down to fund their retirement. 

The Fed has no concerns if inflation takes hold. As a consequence US Treasury yields have risen in response. The future is currently full of uncertainties. 

Golden era of bonds (UK Gilts) was between 1982 and 2014. With a real rate of return to maturity of some 4% above inflation . The historic data spanning 1900 -2019 returns just an average of 0.9%. 

JohnWinder

Nice discussion. A couple of issues came up for me.

Linton said:

On specific objectives:

1) Short term expenditure:
2) Medium term expenditure:
3) Long term comfort blanket, the objective being to ensure that investors don't lose sleep during a crash with the danger that they convince themselves to sell out.   I am with Malthuisian here.  This is mainly a problem for relatively inexperienced investors who could well look at their equity investments separately.  A good answer would seem to be to use multi-asset funds at an appropriate risk level as one would naturally look at the fund as a whole.  If one doesnt have the knowledge to do a job properly it is best to pay a professional.
4) Income:

Without suggesting there's anything wrong with thinking along those lines, it's only about retirement investing. The thread, until that point, was about accumulation and retirement investing. Only 3) seems to have broad relevance, and it well describes a '60/40' type approach with which one chooses two types of assets: equities for growth, and a very low risk bond/cash component, in a balance to suit your nerves (or your advisor's nerves if they're helping you). It doesn't need to be any more complicated than that, although it can be by: borrowing to buy the equities, thus enhancing any positive returns; substituting for some gold or other commodities; including direct real estate if diversification is possible, or putting the assets into mental buckets if it aids thinking.

Linton said:

Why would you want to reduce volatility whilst allowing reasonable gains? 

Indeed you might want to reduce volatility because 'volatility drag' can reduce overall returns if they're measured by the somewhat misleading 'average returns per year' measure. An asset that halves in value after the first year, then doubles in the second year has an average return of (100-50)/2, but has gone nowhere. Whereas an asset which increases 25% in the first, and then 25% in the second year is a horse of a different colour.

https://resourcereit.com/insight/volatility-drag-investment-returns/

MaxiRobriguez said:

People picked up 60/40's in the past despite having a range of investing desires - ultimately they were using the bonds as a hedge against the equity element. That's probably not as appropriate as it was given where the world is now, and the llikelihood of inflation being greater than deflation I would guess.

I'm not convinced it's not as appropriate these days. Firstly, whatever these days are like we don't know what the future's days will be like, and secondly, we have inflation protected government bonds now for some of our 'minimal risk' assets. Cash might be a better option than high quality bonds for the 'minimal risk' portion these days, but the long history is that short term bonds have better returns than cash except in the very short term, and they have some built-in inflation protection otherwise no one would lend the bond issuer money for a period during which they'll lose to inflation if they can get the same returns with cash (which can be withdrawn as soon as inflation shows up). We'll all choose somewhat different approaches, not knowing which will turn out better at the end - c'est la vie.

Linton said:

60:40 equity/bonds is a moderately safe rule of thumb that people can use with very little thought.   But it is a rule of thumb and as such it does not pay to question the details too much as the whole  basis may look shakey.

I think we can question the details carefully and still find it stacks up. As a generalisation, we want the highest risk-adjusted returns possible, which can come from diversified equities (if you can't afford diversified direct real estate - and perhaps even if you can), but we can't put up with too much return volatility, so we choose a comfortable mix of two contrasting assets to get the balance right. The results might turn out as we expect, or not, but there are (imperfect) ways to deal with the 'not' if it eventuates.

Prism said:

This is the bit I am still to decide on. I could go it alone and use a combination of cash, short/medium duration bonds, index linked bonds and gold to make up this allocation - the bit in the original simple model which was 40% bonds. Or I could use a reliable wealth preservation fund or two and then reduce my equity allocation by a certain amount as many of those wealth preservation funds include a good chunk of equities too. My main worry with that is that the fund managers make significant allocation changes without me spotting it which would require me to adjust my own equity pot to stay in balance. I guess what I really need is a wealth preservation fund that doesn't contain equities.. I guess thats a strategic bonds fund.

My main worries would be: on a risk-adjusted basis most actively managed funds underperform a comparable index after about 5 years. Is that what a wealth preservation fund is? Secondly, the costs of that fund would be higher than a diversified government bond index fund or cash account; are they? Thirdly, I'd struggle a bit more to have a sense of how risky my portfolio was compared with a simple equity/government bond or cash mix because I have a good sense of the history of the volatility of those assets over 80 years; not so the wealth preservation fund, as appealing as its name is.

If you need a wealth preservation fund that doesn't contain equities, you also need one that doesn't contain higher risk bonds or illiquid infrastructure, surely; in which case you're left with something like a government bond fund. Simplicity appeals more or less to different folk at different stages of their lives.

Thrugelmir said:

...offered above inflation rates of return, i.e. positive yields. They no longer do.  Cash doesn't provide the solution now. So requires equities to perform even more of the heavy lifting to compensate. Not a comfortable position to be skewed towards equities

There's another dimension beyond getting the equities to do more heavy lifting. Just face the reality that the returns on investing are not always the same over different periods. Sometimes we will have to accept lower returns if we want to keep our risk the same. Work longer, save more, spend less are some alternatives; not necessarily better, but let's have them out there.

Thrugelmir

JohnWinder said:

Thrugelmir said:

...offered above inflation rates of return, i.e. positive yields. They no longer do.  Cash doesn't provide the solution now. So requires equities to perform even more of the heavy lifting to compensate. Not a comfortable position to be skewed towards equities

There's another dimension beyond getting the equities to do more heavy lifting. Just face the reality that the returns on investing are not always the same over different periods. Sometimes we will have to accept lower returns if we want to keep our risk the same. Work longer, save more, spend less are some alternatives; not necessarily better, but let's have them out there.

Unless you expose yourself to higher equity allocations. Then you may well miss out on the superior periods of performance. In effect attempting to time the markets. Which is proven not to be an ideal investment approach. For most people building a retirement pot of size is a life times work. Where compounding is ultimately the real star.  Once over 50 then employment becomes far less secure, new jobs may offer less salary etc. What really counts is the foundations blocks laid in the very early years of ones career. 

DairyQueen

ivormonee said:

Everyone invests in a way that is unique to them, even though they may share the same, or closely resembling, goals and attitude/ approach to risk. Similar levels of return can, and are, achievable through quite different portfolios, with different asset allocations and varying ongoing strategies, and all for a similar level of risk when measured by standard portfolio measurements such as standard deviation (volatilty).

I'd like to specifically look at "balanced" investors in this thread, those who are neither particularly cautious nor "aggressive/ adventurous" with their portfolio construction. Traditionally, this has been the domain of the "60/40" investor, or Morningstar's "moderate" and "moderately adventurous" categories (which cover funds with around a 60% equity composition, although this does vary through time and different funds within each category will vary in their equity allocation).

The questions: How do you construct your portfolio? Do you choose actively managed or index tracking underlying funds? How do you pick them? Just a small number of funds or many? And how to you measure performance? What benchmark(s), if any, do you use?

Care to share your portfolio (ie. list of funds with percentage allocation to each). I hope for this thread to prove to be informative and insightful. What would be a real bonus will be to see if people's different approaches provides any clues to methods and practice that yield better results as well as any patterns that may emerge.

Our individual portfolios are structured to accommodate our different tax/drawdown positions but the portfolios are consolidated to manage our shared objectives, risk and asset allocations.

I don't use a benchmark but intermittently check performance against the AFI Indices on trustnet to make sure I am not drifting off course.

I am wary of bonds so cash and equity allocations are higher, and bonds lower, than would have applied pre-QE. The portfolio assumes drawdown over a period of 30+ years and the withdrawal rate will be lower from 2025. We are front-loading drawdown so the next 5 years of withdrawals are in cash (13% of portfolio). 9% bonds reduce volatility a smidge and add diversity. I aim to maintain around an 80% equity allocation (currently 78%) plus sufficient cash to fund a rolling 5 years of withdrawals. The balance will be in bonds. 

I hold a core of global passives supplemented by actively-managed, regional small-cap funds.  I am not a pedant about regional allocation relative to share of global market cap so am deliberately high UK (15%) and China (7%), and low US (41%). The rest are reasonably close to their respective share of global capitalisation.

I choose funds based on my research. Is there any other method? 

Prism

JohnWinder said:

Prism said:

This is the bit I am still to decide on. I could go it alone and use a combination of cash, short/medium duration bonds, index linked bonds and gold to make up this allocation - the bit in the original simple model which was 40% bonds. Or I could use a reliable wealth preservation fund or two and then reduce my equity allocation by a certain amount as many of those wealth preservation funds include a good chunk of equities too. My main worry with that is that the fund managers make significant allocation changes without me spotting it which would require me to adjust my own equity pot to stay in balance. I guess what I really need is a wealth preservation fund that doesn't contain equities.. I guess thats a strategic bonds fund.

My main worries would be: on a risk-adjusted basis most actively managed funds underperform a comparable index after about 5 years. Is that what a wealth preservation fund is? Secondly, the costs of that fund would be higher than a diversified government bond index fund or cash account; are they? Thirdly, I'd struggle a bit more to have a sense of how risky my portfolio was compared with a simple equity/government bond or cash mix because I have a good sense of the history of the volatility of those assets over 80 years; not so the wealth preservation fund, as appealing as its name is.

If you need a wealth preservation fund that doesn't contain equities, you also need one that doesn't contain higher risk bonds or illiquid infrastructure, surely; in which case you're left with something like a government bond fund. Simplicity appeals more or less to different folk at different stages of their lives.

Wealth preservation trusts have a main objective of preserving value so that would fall in line with a benchmark of RPI or CPIH rather than the more typical equity or bond index that other funds may use. They also of course aim to grow value as well but that is a secondary concern. They use the usual equities and bonds to do that but because they don't follow an index are much more free to take bigger positions in whatever is likely to meet those objectives. For example Personal Assets Trust is currently 35% US index linked bonds and 9% gold Personal Assets Trust > Performance & Portfolio (patplc.co.uk) , with nothing in traditional bonds. If you did want to compare against a passive example then VLS40 might be a decent match but the trust will adapt allocations as required whereas the 40/60 of VLS40 is fixed. 

They can be considered all in one funds during retirement but also do a pretty good job of reducing volatility of any portfolio. Being active the charges have to be considered at 0.74% at the moment