Our portfolio consultants regularly work with advisors and institutions to develop asset allocations – that perfect mix of stocks and bonds – to ensure financial success. And you know what? That mix often ends up in the ballpark of 60% stocks and 40% bonds. Sure, there are outlier allocations, but the 60/40 (aka “moderate” or “balanced”) allocation dominates all others in usage.
This simple asset allocation provides investors with the best of both worlds – a healthy dose of equities to produce long-term growth and enough in bonds to preserve capital and offer modest income. Importantly, the bonds help dampen volatility so the investor can stick with the allocation through turbulent times.
But this simple allocation can quickly turn complex as the pie gets sliced into many pieces in hopes of outperforming a benchmark. Considerable time is spent looking for “alpha” opportunities in the pursuit of higher returns, lower risk, and/or broader diversification.
Just how simple?
In our experience, it’s not uncommon for a balanced model to hold 20 or more investments. Some of these are core beta positions, some offer unique risk factors, some are tactical positions, and some are just redundant. Part of the portfolio consultant’s job is to uncover those redundancies and offer suggestions for consolidation. A golf analogy illustrates the point: You’re allowed only 14 clubs in your bag, so make sure each club has a role – having three drivers is wasteful. The same is true with investments: Don’t overcomplicate it; simple is often better.
So how simple should a portfolio be? It depends on who you ask. In The Simple Path to Wealth, author JL Collins argues for a two-fund portfolio – a total stock market index fund and a total bond market index fund. Figure 1 shows how a 60/40 portfolio would have done historically, using the S&P 500® mixed with the Barclays Aggregate Bond Index or the Barclays Municipal Bond Index. With only three negative years in the past 21, this mix has been a relentless compounding vehicle for investors. It’s earned well above the 4% safe withdrawal rate most retirees benchmark themselves against.