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Rupert Hargreaves
Rupert Hargreaves
Articles (687)  | Author's Website |

Asset Allocation: Is the 60-40 Portfolio Worth It?

Returns don't seem to compensate for the risks

December 27, 2018 | About:

A few days ago, I wrote on the performance of the "Permanent Portfolio" over the past few decades.

Invented by Harry Browne, a U.S. writer, and politician, and first published in the 1970s, this simple portfolio only really had one aim: to protect investors' cash.

Permanent returns

The Permanent Portfolio is so simple, it's almost too easy. The portfolio is separated into four buckets: 25% cash, 25% gold, 25% shares and 25% long-term government bonds. The idea for this asset allocation is to provide a hedge in all adverse market environments. Gold provides a hedge against inflation and Black Swan events, bonds offer a steady income and should outperform in recessions, stocks should grow steadily over the long term, and cash provides yet another cushion against unforeseen setbacks.

I don't want to get into a debate as to whether or not this is a suitable portfolio for any investor, but when I am interested in is the returns from the strategy. As I noted before, since 1970, the Permanent Portfolio has produced an average annual return of 5%. In comparison, a 60/40 stock bond portfolio has provided an average yearly return of 5.9% since 1970.

In many ways, I was surprised by this return figure. Without the data, I would assume that the returns from the permanent portfolio would be only slightly positive because of the high weighting towards cash and gold.

What shocked me more, however, is the performance compared to a traditional 60/40 stock bond portfolio.

60/40 drawbacks

The 60/40 portfolio is a mainstay of asset management and is designed to give investors the best returns, but at the same time, minimize volatility.

We know that over the long term, stocks generally outperform bonds, cash and gold. With this being case, it is easy to assume the traditional 60/40 portfolio will beat the Permanent Portfolio on a long-term basis by a significant margin.

But after crunching the numbers, it becomes apparent that this is not the case. As noted above, since 1970, the 60/40 portfolio has only outperformed the Permanent Portfolio 90 basis points per annum or 0.9%.

Over a period of three decades, this extra 0.9% per annum will make a big difference to long-term returns. For example, $1,000 invested at a rate of 5% per annum compounded annually will grow to be worth $4,321 after three decades. The same amount invested at 5.9% over the same period will increase to be worth $5,593, an improvement of $1,273 or 29%.

Nevertheless, despite this improved return, I find myself wondering whether or not investors would be able to hold through the additional volatility that comes with the 60/40 portfolio.

Is volatility worth it?

Investors using the Permanent Portfolio approach since the 1970s will have experienced several bad years. 2008 was particularly bad with an estimated loss of 4.4% according to portfoliocharts.com.

The most substantial drawdown the portfolio has suffered in the 47 years between 1970 and 2017 is 14% and lastest for five years. In comparison, the deepest drawdown sustained by owners of the 60/40 portfolio was 34% and lasted 12 years. The average standard deviation of returns for the Permanent Portfolio is 6.9% compared to the 60/40 portfolio standard deviation of 10.8%.

We know from other studies that investors are generally pretty bad at timing in the market and even worse at holding through volatility. Most investors tend to sell at the bottom and then only buy back when the recovery is well underway, missing valuable gains. This leads me to ask the question: Is it worth taking on the extra volatility for the 0.9% in additional returns? All it would take is one miss-step on the part of the investor to blow up this slim profit margin.

Some interesting food for thought. Once again this is not supposed to be asset allocation advice, it is just some thoughts on the process of asset allocation and possible returns on offer from a different portfolio.

Disclosure: The author owns no share mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


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