Time To Ditch The 60/40 Rule

By: Jussi Askola

Summary

  • The 60/40 rule is a common yardstick that investors to rely on in constructing their portfolios.
  • It says you should put 60% of your portfolio in stocks and 40% in bonds.
  • The problem is that it isn’t suited to the realities of today’s market.
  • In this article we propose an alternative to investing according to the 60/40 rule.
  • Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Get started today »

The 60/40 rule is an approach to investing that worked well in the past. If you’re not familiar with it, it says that you should put 60% of your money in stocks and 40% in bonds. And rebalance every year so that the weightings always are at 60/40. The stocks increase your expected return while the bonds provide income and reduce volatility.

By all accounts, the 60/40 portfolio has a good track record. According to Schroders, it provided better returns from 1988 to 2018 than stocks or bonds alone:

By rebalancing, you would have achieved better returns with a 60/40 portfolio than with stocks – the higher return asset – alone!

So as we’ve seen so far, the 60/40 portfolio with rebalancing boosted total returns over the last 30 years. It undeniably lowers risk, by getting bonds into the mix. And on top of that, the lower volatility means you’ll have a less stressful experience over the course of your life.

That all sounds good on the surface. But there’s just one problem. 

In 2020, both assets in the typical 60/40 portfolio have serious problems with them. Stocks are extremely overvalued and volatile, and bonds yield next to nothing.

Past performance does not predict future performance. And there are good reasons to think that a 60/40 portfolio might do much worse over the next 30 years as it did over the last 30.

In this article, we make the case that you should avoid investing by the 60/40 rule and buy real assets instead. We’ll start by reviewing the flaws with stocks and bonds and move on to why real assets are superior today.

Stocks are Overvalued

According to the Wall Street Journal, the S&P 500 (SPYhad a 41 P/E ratio as of Dec. 11.

That’s more than double the historical average.

Historically, stocks tend to fall back to the point where their P/E ratio is at about the mean. That would imply they have a long way to fall.

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That doesn’t guarantee that stocks are going to be losers over the next 10 or 20 years. But the higher they rise relative to earnings, the riskier they become.

To be sure, corporate earnings have soared over the last decade. But look at what made that possible. We’ve seen continuously low interest rates, culminating in near zero interest rates today.

Low interest rates stimulate spending, which drives corporate earnings higher. But now that interest rates are near zero, where do we go from here? The only option left is negative interest rates, and central banks are reluctant to go there.

So there are few monetary policy options left to stimulate the economy. This is why Ray Dalio recently forecast a “lost decade” with 0% returns, and Jeremy Grantham forecast negative returns.

There’s just a lot of risk factors impacting stocks right now. So far this year, we’ve seen mostly a positive trajectory with extreme volatility in between. But you never know when a new crash will occur that will take a decade to recover from.

Bonds Have Next to No Yield

Now that we’ve reviewed the problems with stocks, we can move on to the second asset class in the 60/40 portfolio: Bonds.

In a traditional 60/40 portfolio, bonds provide the safety and return smoothing component of the portfolio. They return less than stocks but they have more stable, and dependable returns. Having bonds in your portfolio in the first place reduces volatility. If you rebalance, they can even boost total return.

The problem is that today, bonds have so little yield that they’re almost pointless. As of this writing, the 10-year Treasury yield was 0.91%. That doesn’t keep up with inflation most years. Of course, you could up your yield by getting into a junk bond ETF. But that dramatically increases your risk, which defeats the purpose of having bonds in your portfolio in the first place.

Consider the SPDR Bloomberg Barclays High Yield Bond ETF (JNK). This year it went on a wild ride, dropping 22% at one point. And its price is barely up (2.47%) over five years.

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Sure, it has yield. But from a total return perspective, it hasn’t done well. And in the meantime, it has delivered a fairly volatile ride this year. So such a high risk bond play isn’t going to smooth out your portfolio.

So, on the one hand, we’ve got the genuinely “safe” bonds that have no yield. On the other hand, we have high-yield bonds which are very risky – going against the whole thesis of holding them in your 60/40 portfolio. So what’s an investor to do?

Here’s What We Are Buying Instead

Having established the flaws with stocks and bonds in today’s market, it’s time to dive into what we recommend as an alternative:

Real assets. 

Real assets are assets with a real, physical substance that often produce substantial cash flows.

They include:

  • Apartment buildings.
  • Warehouses.
  • Railroads.
  • Hospitals.
  • Farmland.
  • Timberland.
  • And more.

Today, I invest about 50% of my net worth in real assets that are resistant to recessions. While some real assets get killed in recessions (e.g. hotels), others are very stable. It’s that latter category I’m focused on. Some of the biggest sub-sectors in my real asset portfolio include:

Apartment communities in business-friendly Sun Belt states:

Waller Creekside on 51st Austin, TX | Welcome Home

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Service-oriented net lease properties with 10-year leases or longer. Our tenants are major chains such as Taco Bell (QSR): 

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Healthcare facilities that are set to profit off the aging population.

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Warehouses that are leased to Amazon (AMZN) and other rapidly-growing e-commerce companies.

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These real assets allow us to enjoy many of the features you can’t get with most stocks and bonds today. These include:

  • High yield. My portfolio is made up of assets that yield 5%-8% and have regular dividend increases.
  • Predictable cash flow. The assets I own are backed by long-term leases that ensure revenue stability.
  • Upside potential. Most of the assets in my portfolio are trading at their highest yield spreads in a decade. They have 30%-50% upside as yield spreads return to normal.

How Do I Invest in Real Assets?

After having worked in private equity and bought real assets directly in the private market, I have today shifted my focus to the REIT market. 

If you’re used to investing in stocks, then REITs (VNQ) are by far the easiest way to get into real assets. You can buy and sell them through your brokerage account just like stocks, and they’re backed by portfolios of real assets.

Over the past 20 years leading to the recent crisis, REITs easily outperformed the 60/40 portfolio strategy and most other asset classes: 

Today, REITs look poised for another decade of outperformance. After falling in the COVID-19 market crash, many REITs are trading at substantial discounts to fair value, and as a result, yields are higher and the potential upside is greater than usual.

Of course, sometimes assets go down for a good reason. Yet many high-quality REITs remain down even despite not being greatly affected by the crisis. 

Take the example of W.P Carey (WPC). It owns mainly industrial properties that are in great demand and enjoy >10-year leases with high credit tenants. Throughout the whole year, WPC has collected nearly 100% of its rents and has kept buying new properties to grow the cash flow. It also has a strong BBB-rated balance sheet and plenty of liquidity. By all accounts, things are going well for the business, and it has even increased the dividend in 2020, continuing its 20-year-plus track record of dividend growth. 

Yet it’s down 23%, so you can invest in WPC’s real assets, lock in a 6% yield, and enjoy ~30% upside as the REIT returns to a fair valuation. 

High yield. Significant upside. And lower risk. That’s nearly impossible to find in the stock and bond market today. 

WPC-owned distribution center that is leased to Advance Auto Parts (AAP):

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Bottom Line: You Need to Adapt Your Portfolio

A 60/40 portfolio has performed well over the last 30 years, but now bonds yield close to nothing, and stocks are overvalued. 

What are your other options?

If like me, you want to earn income and position yourself for double-digit total returns, then nothing beats real assets in today’s market.

As more investors come to the same conclusion, we expect a lot more capital to rotate toward real assets. The time to act is now while others are still fearful, valuations are low, and yields are high. 

Published by

Gregory Owens SR

Retired from the military in 2015 after 38 years of service, and decided to start my own blog directed towards my life’s passion of sports, military, and a whole lot more.