The 60-40 Portfolio

Have you ever heard of the 60-40 portfolio? 60% in stocks and 40% in bonds, or bonds and cash. This is the most common stock to bond allocation used for retirees.

The 60-40 didn’t get to where it is by chance. Believe it or not there are people who dedicate a portion of their lives to studying the best way an individual can maintain their standard of living through retirement without running out of money. These folks researched, using historical data, various mixes of stocks, bonds and cash, and found that something “between 50-50 and 70-30” would likely work best (assuming a 4% of portfolio initial withdrawal rate and annual inflationary increases to the initial withdrawal).

It might feel like a retiree portfolio should be safe and have lots of fixed income holdings, however, too much fixed income actually increases the odds of running out of money (or not maintaining a given standard of living). Most people want to plan for at least a couple of decades in retirement (average mortality now 87.6 for women and 85.6 for men).

There’ve been lots of follow-on studies based on the original research and sometimes the findings, depending on assumptions, don’t result in the exact same conclusions, but the work must go on. We’ve observed/managed real 60-40 portfolios that started during the high tech bubble, and lived through the financial crisis, which have not only allowed for ongoing monthly income for the retiree but also grown in value.

During the financial crisis our oldest portfolio dropped by 35% (normal given the extreme circumstances). However, the portfolio recovered and is now the biggest it’s ever been. Volatility can be frightening but, if the timeframe is long the likelihood of a desirable outcome is higher by having more stocks than bonds. Stocks are very likely to make a lot more over long periods of time (decades) than bonds and thus give us what we want: more monetary resources with which to live our lives.

Another way to think of the amount of safer assets (bonds and cash) to have in a portfolio is the number of years of withdrawals we might need to ride through a significant downturn. Historically, 3 years of tough times is pretty long and simple math tells us that a 5% of portfolio withdrawal times 3 is only 15% of the portfolio. 5% times 5 years is only 25% or a 75-25 portfolio. A 75-25 portfolio might be more volatile than most people can stomach and so something closer to a 60-40 portfolio is chosen by many.  However, for someone with decades before them in retirement a 70-30 portfolio certainly isn’t unreasonable, and, might yield a better standing of living.

One can also put allocations of very safe securities, like short-term government bonds, in a portfolio. Short-term government bonds are not only likely to maintain value in a crisis but may even increase in value. During a recession monthly cash distributions from a portfolio can come from the safer pieces of the portfolio while the more volatile pieces recover.

Taking the long view and making educated choices can get us where we want to be in retirement.  Taking comfort in conservatism is likely to provide the exact opposite.