The price of security is insecurity

It can be said, I suppose, that if you sit on a hot stove with your head in the freezer, you should theoretically be comfortable. That’s the problem with theories. Sometimes they’re just dumb.

Some people try to apply a similar logic to investing, hence the creation of the perennially popular and occasionally maligned “60/40 portfolio.” Keep 60% of your money in equities for long-term growth, the theory goes, and the other 40% in fixed-income securities for stability and income. Historically, this investment mix has produced a higher return than bonds over time with less volatility than stocks. Novice investors (and in some cases their novice financial advisors) often refer to a 60/40 allocation as the “all-weather portfolio.” In theory, you expect to be comfortable with it.

But 60/40 investors were anything but comfortable a few years ago. The S&P 500 was down 18% in 2022, and the Bloomberg US Aggregate Bond Index dropped 13%. A 60/40 portfolio that tracked those two indices would have lost about 16% for the year. Not the kind of weather most investors were expecting.

That’s not to say that a 60/40 investment allocation is a bad idea. Truth is, the largest percentage of the portfolios we manage for our retired clients comes pretty close to a 60/40 mix most of the time. We just get there a different way.

Most of the investing articles that you read approach “asset allocation” as a one-time decision, like buying clothes off a rack: “You think you’re a 70/30? You’d probably look much better in a 60/40 – there’s a lot more room in the seat.”

When it comes to designing investment portfolios, financial journalism offers little help:

• At the beginning of 2022, Kiplinger Magazine pronounced: The 60/40 Portfolio is Dead.  

• And yet just 16 months later, the same publication declared: 2023 Could Be the Year to Welcome Back the 60/40 Portfolio.

Apparently, when you’re trying to sell magazines and ad clicks, things just don’t stay dead for very long these days.

There is an asset allocation that’s right for every investor depending on his or her investment goals, time horizon, and tolerance for uncertainty. It’s just not the same one for everybody – especially if you’re just looking at how it performs in a given year.

We have always believed that how you invest each dollar of your portfolio should be based on how soon you want that dollar back to spend. If it’s money you plan to use within the next 12 months, keep it in cash or its equivalent. If your time horizon is longer than one year but shorter than five, you’re more likely to get better returns from bonds or other fixed-income investments. Beyond five years – and especially beyond 10 years – history tips the odds solidly toward owning equities.

The portfolios we build and manage for our clients begin with that premise and the trade-offs it implies. Short-term investments are more likely to satisfy the need for day-to-day stability, and we accept lower returns they offer in return in order to sleep at night. Longer-term investments, such as equities, are more likely to give us better returns over time but disappoint – even frighten us – if we insist on measuring their progress over too short a time frame.

Once we know an investor’s planned withdrawals over the next five years or so, we are able to justify their financial need to have that portion of your portfolio invested more conservatively. But they might also have an emotional need to have additional funds invested this way, even though they have no plans to withdraw them anytime soon. They might see better returns over the long run without that emotional cushion (theory), but if they can’t sleep at night (reality), then they won’t be able to give their investments enough time to do their job. And what’s the point of that?

The price of security is insecurity.

That’s a very succinct way of saying that you can choose to feel financially secure in the short term by investing in things that don’t fluctuate much. But your decision also makes it more likely that you will feel insecure in the long run because of the low returns you’re likely to earn. Conversely, the more insecurity you’re willing to bear today, the more financially secure you’re likely to be in the future. Your choice.

It’s not an either/or decision. And it’s not about whether 60/40 is better than 40/60 or 80/20. It’s about understanding your financial needs and your emotional needs in designing a portfolio and then accepting the tradeoffs that will always be part of the bargain.

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Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Mike Brown and not necessarily those of Raymond James.