60/40 Portfolio: What You Don’t Know Can’t Hurt You? by Attain Capital

We’ve been seeing more and more posts lately (perhaps it’s just our reading list) that essentially say something along the lines of – why make everything so complex in investing, just stick with the simple stuff. The latest culprit comes from Reformed Broker, suggesting that while the traditional 60/40 portfolio surely isn’t the best portfolio, an average investor probably won’t know the difference between it and a better one – in advance – so why try. Here’s what he had to say:

“Are there better ways to invest than the classic 60/40? Sure there are. Will you be able to identify them in advance? Can you bear the added risk of a portfolio tilted toward higher expected returns, through the really rough times where that extra return is actually earned? What are the costs associated with supposed “better” investment strategies? Can they be justified on an after-tax, net of transaction expense basis?

Those questions are probably some pretty high hurdles for a lot of the so-called “better” or more exciting strategies to surmount, no?”

We’ve been through this before. First, with Business Insider looked at the past 20 years of returns. Next came, one of our favorite bloggers, Barry Ritholtz saying simple beats complex. We looked back at the past 3 cycles (every 5 years) after that read, and found that simple beating complex wasn’t as simple as it has appeared over the past few years, showing a bit of recency bias. In the latest attempt, Reformed Broker uses a chart from Research Affiliates’ Chris Brightman to show that the old standy 60/40 portfolio has an annualized rate of return of 6.5% and volatility at around 9% – putting it square in the middle of all these other more complex investments designed to beat it.

60/40 portfolio

(Disclaimer: Past performance is not necessarily indicative of future results)

Chart Courtesy: Reformed Broker

Our quick thoughts on this chart:

1. It forgets the other crash.

“But now consider the fact that this period, between 2005-2014, encompasses one of the worst stock market crashes and economic downturns in history.”

What would happen if you moved the last 10 years, to the last 15 years to include the tech bubble crash? Something tells us those numbers might be a little different.

2. It Assumes Volatility is Bad.

We’ve been over how there’s more to risk than volatility (making the Sharpe ratio not so sharp). And depending on where you are in your investment journey, low volatility can actually dampen your opportunities for gains. For more on this see our “Low Volatility not so Smart.

3. Bonds = Great! Anything with 40% bonds in it has been stellar the past 5 years, as bonds have defied gravity (cue Wicked chorus). Add the ‘09 to ’14 stock market rally, and it’s no surprise the 60/40 is looking great alongside everything else. This is like saying Tom Brady is great right after he wins the SuperBowl. Saying he’s going to win it again next year is an entirely different, thing, however.

4. Commodities Suck? We wish the entire ‘Commodities’ asset class was re-named ‘Long-Only Commodities’, because that is the thing causing terrible returns with volatility. Commodities at –4% annualized return, and a roughly 18% volatility. That’s rough. But Reformed Broker, haven’t we’ve bugged you enough by now to merit at least a mention of the asset class that goes both long and short commodities – managed futures. They use commodities, but don’t look like commodities when measuring return over volatility. If you want to learn more about it check out our about Managed Futures page.

5. Speaking of Managed Futures. If we add them to the table – here’s how that would look. And if we did a single program – our Attain Trend Following Fund would literally be off the chart… above the title. But they could counter with their own ‘off the charts’ single stock with Apple or similar, which is a fair point. So we added Managed Futures as a whole via the Newedge CTA Index.

60/40 portfolio

(Disclaimer: Past performance is not necessarily indicative of future results)

Managed Futures = Newedge CTA Index

We’ve done this before (looking at “other” efficient frontiers), but what if we look at the old 60/40 side by side with a portfolio which diversifies 30% into Alternatives (and not just any alternatives – our particular brand, managed futures. Here’s what we found.

60/40 vs. Diversified

60/40 portfolio

(Disclaimer: Past performance is not necessarily indicative of future results)

Explanation: ROR = Rate of Return, 60/40 = 60% Stocks (S&P 500) + 40% Bonds (Barclays U.S. Aggregate Bond Index).

30% alts = 42% Stocks + 28% Bonds + 30% Newedge CTA Index

(Data From : 2005 – 2014 )

The next time there’s an article out there looking at various asset classes over the past 1, 3, 5 or whatever time period…. step back and ask yourself – if I moved those dates ranges by a couple weeks, 6 months, 2 years, 5 years; how different would those returns be? Josh Brown surely knows the average 60/40 investor better than most, and definitely better than us. But it seems insulting to their collective intelligence to assume that these 60/40 folks wouldn’t be willing to “jump over hurdles” to find something that might be better than what has been. They surely know that stocks are at all time highs and interest rates are at all time lows, and we can surely all agree that that game can’t last forever – even if it can last for much longer than we think it can.