By BRETT ARENDS
What if everything your investment adviser is telling you is wrong?
Look at the mutual fund choices your company is offering in your 401(k) plan. Look at the portfolio of those "target date" funds you're supposed to rely on, with their long-term-return forecasts and their so-called glide path to retirement. Look at the asset-allocation plan your financial adviser has drawn up.
Chances are, when you cut through the jargon and the spin, they're all based on one big assumption: that a balanced portfolio of stocks and bonds, rebalanced regularly, will see you through whatever comes next.
Could that analysis be off base? "It can't be," say the investment advisers. "Look at the data! Going all the way back to the 1920s, a standard portfolio of 60 percent stocks and 40 percent bonds, rebalanced regularly, would have made you about 8 percent a year. And if you had taken on more risk, by owning more stocks and fewer bonds, you could have earned even more.
"So don't worry about the market, and volatility. If stocks go down, your bonds will go up, and vice versa. Just create an appropriate portfolio of the two, based on your age and risk tolerance, and rebalance it once or twice a year. You'll do just fine."
Sounds good, right?
Here's the problem: This entire strategy is based on a dubious reading of history, a misrepresentation of the facts and a fair amount of sleight of hand. And it's terrifying to think that so many people are relying on it nonetheless.
I never cease to be amazed at what passes for logic and historical analysis in the finance industry. With a click of a mouse, analysts extrapolate the future from the recent past. They claim to derive universal rules from a few decades' data. They ignore the costs and problems of the real world. They gloss over averages, hide behind mumbo jumbo and pile circular arguments upon non sequiturs to build their case. And these are your life savings they are putting at risk!
And do not take false comfort from the fact that so many people in finance say the same thing. Their marketing departments are telling them to push conventional products, because those are the easiest to sell. And their lawyers are telling them to push the same thing as everyone else -- so if things go wrong, they're covered. Performance? That's not their problem.
Here's the ugly truth. Contrary to what you are being told, this 60/40 portfolio of stocks and bonds comes with no guarantees. There have been long periods during which it has done very badly.
And why should we be surprised? There is nothing magic about stocks or bonds. They are just investments. A balanced portfolio of the two makes you money only if one, or both, is reasonably valued. In the early 1980s, they were both cheap. Today, in an environment where by some measures both look expensive, all bets are off.
First, look at the present situation. U.S. stocks, after a three-year boom, are now at very high prices compared with dividends, the replacement cost of company assets and the past 10 years' earnings -- three measures with a decent track record of predicting long-term performance. As for bonds? Their yields are desperately low, especially when compared with inflation. It's hard to argue that either asset class is cheap.
What about the track record? I took a look at the data, as compiled by the Federal Reserve and analyzed by New York University's Stern School of Business. I created a hypothetical 60/40 portfolio and tracked it over the past 85 years, rebalancing it annually.
My analysis? That "average return of 8 percent" is full of holes. First, it ignores inflation. Adjust for that and you're left with just under 5 percent a year -- a big difference. Second, the "average" return is meaningless. Most of the gains came in two booms: during the 1950s, and in the past 30 years. For many other periods, the returns were meager, or nonexistent.
From January 1, 1937, through January 1, 1950, a period of 13 years, this surefire 60/40 portfolio, rebalanced annually, earned you absolutely nothing after inflation. Zip. The story was the same from 1965 to 1982 -- a slump that lasted nearly two decades.
In the real world, investors did even worse than zero. They paid trading costs, fund-management fees and taxes. Many just gave up along the way. Meanwhile, toddlers grew to college age, and middle-aged couples reached retirement. And the money they were counting on wasn't there.
The bottom line: In the decades leading up to the early 1980s, the record of the 60/40 portfolio was decidedly mixed. Yes, the returns of the past 30 years have been gigantic. But to include those blithely in your forecasts is to engage in a circular argument: "They have skyrocketed in price, so you should buy them!" Of such nonsense was "Dow 36,000" -- and the Las Vegas real estate boom -- made.
Where does this leave investors now? "There is no magic answer," says Charles de Vaulx, a money manager at International Value Advisers in New York. "But one has to look beyond stocks and bonds. One needs to consider TIPS [Treasury inflation-protected securities], gold, commodities and cash as well." John Hailer, CEO of fund company Natixis, says investors should look into "alternative strategies," such as those involving derivatives. "There are other ways to mitigate risk than just being in stocks and bonds," he says. But that raises the challenge of performance and costs.
In a recent paper for the Investment Management Consultants Association, Alex Shahidi, an adviser at Merrill Lynch, argued that passive, low-cost investors should jettison the 60/40 conventional wisdom for a portfolio of 20 percent stocks, 30 percent long-term Treasury bonds, 30 percent TIPS and 20 percent commodities. Since 1926, he calculates, this asset mix has produced the same overall return as a 60/40 portfolio, but in a far steadier way, with fewer down years. This mix has its own issues. TIPS and commodities aren't cheap either these days. Both have risen a long, long way in recent years. But at least investing in four expensive assets instead of two may help your odds.
If you want to follow an approach like this, de Vaulx recommends splitting the commodities allocation in two -- with 7 percent to gold bullion and 13 percent to the rest. Two other strategies may also help: choosing a truly global stock portfolio over just a U.S. one, and investing money over time, so that you catch the lows as well as the highs.
If there is no perfect solution, that is in the nature of the markets. But investors need to be braced for the possibility that the fund industry's simplistic solutions, as well as its optimistic forecasts, come with absolutely no guarantees.