The 60:40 Portfolio Rule Needs a Reboot

David Muhlbaum: One of the grand old rules of investing was a portfolio allocation of 60% stocks and 40% government bonds. That was considered the safe option for many buy and hold investors. But Jared Woodard, head of the Research Investment Committee at Bank of America Securities, says its time is over. He's our guest today in the main segment. And we'll ask him why he thinks so and what investors should be buying instead. Also, Sandy fields a reader question about snowbirds, and we talk about why you pay more for pumpkin spice. That's all ahead on this episode of Your Money's Worth. Stick around.

• Episode Length: 00:25:48
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David Muhlbaum: Welcome to Your Money's Worth. I'm Kiplinger.com senior editor David Muhlbaum, joined as always by senior editor Sandy Block. A few weeks ago, we talked about what a snowbird is and how they can save money. A refresher for those of you who missed that: Snowbird is the term of art for someone, usually a retiree, who spends part of their year somewhere warmer. They fly south for the winter. I mean . . . maybe they drive or they take the auto train. You get the idea. They seek what they consider better weather. It turns out at least one person was listening, and he has his own ideas of what better weather is.

Sandy Block: That's right. Jay, a fan of the podcast who lives in Camden, South Carolina, wrote to us, and this is what he said. He said, "What about reverse snowbirds? My wife and I are looking at getting a summer place in the northeast in a few years, maybe the Catskills or the Finger Lakes region of New York, Poconos." He says, "The summers are brutal here and seem to be getting worse as we age." And they're saving up money. And he wants to know, "Are there retirement communities in the northeast that are akin to retirement communities in the south where we could retreat for six months of the year?" And the answer to that is, you bet. I mean a quick internet search of retirement communities in any of those places that he mentioned will show plenty of opportunities. So I think that's definitely something to think about. I don't have any stats on reverse snowbirds, but our colleague Bob Niedt, who was on here recently, has written about halfbacks. Those are retirees who moved to Florida, grew weary of the heat, hurricanes and bugs and moved to the Carolinas where the weather is more temperate. And we've actually got a slide show on that which we'll put in the show notes.

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David Muhlbaum: Okay. I think Jay might want to keep his eye on taxes, though.

Sandy Block: Well, that's right. Weather isn't the only reason people often move from the north to the south. State taxes, state income taxes tend to be much higher in the northern states. And fortunately for our listeners, we have a retiree tax map on our website, that really does a very exhaustive breakdown of taxes in every state. And this is something that these folks might want to look at if they think they might ever want to move north permanently, because if they make their residency in a place like New York or even Pennsylvania, there's a good chance that they will see taxes higher than they are -- and, again, we'll put the link to this in the show notes. And we are actually working on updating the state retiree tax map as we speak. And one of the things I also wanted to mention, even if reverse snowbirds plan to spend most of their time, establish residency in the south and just spend maybe the summer in the northern states, they should also pay attention to property taxes.

Sandy Block: We have that information on our tax map, as well. And just as state income taxes tend to be higher up north in certain areas and property taxes are kind of local, but they can be much higher too. And if you own property there, you're going to pay property taxes on it. So certainly look at the costs, but I think this is a really interesting idea, something that we should probably write about and we're thinking about doing more on in the future. So I think it's a great question and I thank you very much, Jay, for writing.

David Muhlbaum: Yeah. Jay, we'll have a link to that tax map for you, the retiree tax map, but a couple of states you might want to consider are Virginia, if that's cool enough for you. And then little Delaware is actually one of our most friendly states for taxes on retirees.

Sandy Block: And you can go to the beach.

David Muhlbaum: Coming up in our main segment, we talk to a top market analyst about portfolio allocation and philosophy.

David Muhlbaum: We are back with Jared Woodard. He is head of the Research Investment Committee at Bank of America and has held a lot of high profile research and trading positions at Merrill Lynch and other firms before that. Welcome, Jared.

Jared Woodard: Thanks. I'm glad to be with you.

David Muhlbaum: What we're here to talk about today is one of those old saws of investing, the idea that a good conservative approach was to put 60% of your money in stocks and 40% in bonds, often treasuries or the like. The thinking was that bear market, the government bond portion of the portfolio would provide income to cushion stock losses. And the other related principle was that bond prices would move inversely from stock prices. Stocks down, bonds up, bonds up, stocks down. So first, before you poke holes in that, how long has this maxim been around?

Jared Woodard: Well, I think Jack Bogle was the popularizer of this idea. He was the guy who invented, I mean he launched the first mutual fund in 1976, that index fund. And he founded The Vanguard Group.

David Muhlbaum: Right, Bogleheads.

Jared Woodard: Exactly. And I don't know when exactly 60-40 came into the mix as a part of all that. But it's been around for a really long time.

Sandy Block: Jared, how long has it been wrong? I mean, your argument that it's over is something you've been arguing for a few years now. What has changed?

Jared Woodard: Well, I think there's two reasons to rethink -- especially the bond portion of that 60-40 portfolio. Number one, less reward. Number two, more risk. And maybe I'll take those in turn. Number one, there's less reward from bonds, especially from government bonds and other really high quality safe assets. Less reward than you've ever seen before. Interest rates in bond yields are actually the lowest now basically in all of human history. You can go back a few thousand years and you can't find lower interest rates. Now you can lock up your money for 10 years today in treasuries to earn -- drum roll, please -- 0.8% per year. Now, inflation is expected to average about 1.7% over that time. So in real dollars-to-donuts terms, you're basically committing to losing 0.9% of your money every year just for the knowledge that you'll get your money back at the end of that period.

Jared Woodard: It's like the money you'd have to pay to lock up valuables in a safe, except it's just cash. And it's incredibly expensive to store that cash in this safe asset. So the reward there is terrible. You've gone from getting paid for storing your money to having to pay a cost to store it. So that's one side of it.

Jared Woodard: Number two, more risk. I'll give you a couple examples. After the 2016 election, treasury bonds lost more than 10%, and they actually lost more than investors made in equities over that period in the immediate aftermath of the election. So a diversified investor actually lost money overall on what was a very broadly bullish market reaction. And what's more, I would emphasize this a lot, there are several periods in history where you saw big losses on both stock and bond portfolios at the same time. In other words, that hedging function . . . that insurance function that people usually associate with government bonds didn't happen at all.

Jared Woodard: Many of those periods have been associated with the Federal Reserve raising interest rates, like Paul Volcker in the early 1980s, Greenspan, there was a surprise and 1994 and the taper tantrum in 2013, some people will remember, and we expect the Fed's not going to raise rates for a while. So maybe people aren't worried about those particular examples, but let me tell you one more. At the end of the 1960s, a period very similar to I think what we're looking at today and our near future. You just had the war on poverty, the Great Society, all these big programs to boost employment and income, some of which we've seen similar this year. We also had big infrastructure programs and some other things that are on the policy agenda for a lot of folks in Congress these days. And so there've been all these big measures to boost growth.

David Muhlbaum: A lot of government spending.

Jared Woodard: Exactly. And by the way, we've just come off one of the largest and fastest government budget expansions in U.S. history, you think only World War II, so a faster expansion. And so after that period in the late 1960s, you had a lot of policymakers radically and sharply tightening their budgets. We could debate later maybe whether some of the time, whether they needed to or not. I don't think that they did, but they did anyway. And with that government austerity and with hiking of interest rates to stem what they perceived as a threat of inflation, you saw massive losses. You saw actually both equities and bonds lost nearly 20%. So there have been periods in history already that show us what can happen. And here's what I want to argue. The risk that people are willing to disregard because they've enjoyed a 30 or 40 year rally in bond markets, I think is a risk that they're not fully appreciating because they're not thinking about how the future might look very different from the recent past.

David Muhlbaum: It's interesting you keep saying risk, because I think that the investments you're suggesting as alternatives are going to strike some of these people as . . . risky.

Jared Woodard: That's totally fair. And here's what I'll say about this. If you're going to invest money anywhere, if you're not just going to bury it in your backyard, you have to take some form of risk. Of course, even if you bury it in your backyard, you're bearing the risk of inflation and the risk of theft. So there's no way to opt out of society. There's no way to sort of just check out, take your money and go home and not bear any risk at all. You have to take some form of risk. And the kind of risk people have been willing to take for a long time in these portfolios is the risk of higher yields, higher interest rates, higher inflation, even missing out on a higher growth and they've been right. Let's be clear, because we were in a very low growth world . . . low inflation, low interest rates, low wages. But my argument is that just because the world has looked that way for the past 30 years, I don't think it's going to look that way in the next 30 years. So what do you do instead? Well, you have to take different forms of risk . . . the sorts of risks that I think are more prudent and actually more conservative -- I can use that word -- in the kind of scenarios that we envision for the economy in the near future.

Sandy Block: So in the 40%, are you talking about having more alternatives to government debt or does the percentage itself change? How do you sort of fix this problem?

Jared Woodard: Well, I think you definitely want to think about changing the allocation to government bonds. I think that there's more attractive places to invest, even within fixed income. Here's maybe a different way to attack the problem. If we've got to take risks somewhere, let's think about the kinds of risks that are out there and the kinds that we actually want to have in our portfolio. There's kind of equity risk, like you have the residual cash flows from a business. Maybe the business is worth nothing, maybe it's worth a ton. I mean, that's what you do when you invest in equities. There's the risk of credit, of not getting paid back from a bond security. If you invest in high-quality companies, you can usually minimize that risk.

Jared Woodard: There's the risk of inflation. There's a risk of interest rates. There's risk of liquidity. What if you invest in an asset like real estate that might be really good, but you can't get your money out exactly when you might want to? So those are some different categories of risk. My argument in the broad terms is avoiding the risk you take in government bonds today of higher interest rates, higher yields, higher inflation is really a good idea because these other risks in credit, in equity and in liquidity, I think are much better places to allocate investments. How does that cash out in terms of actual securities or asset classes? Well, I think some corporate bonds, especially corporate bonds of companies that aren't the very top-shelf quality, where you still get paid very little, but companies that are having a little bit more challenge in an overall good economy can be really attractive. Loans to companies from banks or other kinds of leveraged loans that there's some risk of the economic cycle, but don't have any exposure to interest rates because they reset periodically can be really attractive at reducing some of these risks.

David Muhlbaum: How does a retail investor get access to, for example, the bank loan?

Jared Woodard: The great news is that there are low cost, low fee vehicles like mutual funds and ETFs and closed-end funds that are listed on exchanges today that people can buy that provide much better, efficient, more efficient exposure with lower fees than ever before. Many of them have actually excellent liquidity as investment vehicles, even if the underlying assets like real estate maybe aren't super liquid. And so you can get access to these products in ways that I think would have been impossible for most people 20 or 30 years ago.

David Muhlbaum: What we're really talking about is changes to the 40%, what you should be holding on the fixed income side, rather than moving the famous numbers of 60-40. It's more of a change of what's in that 40. Do I have that right?

Jared Woodard: Well, the little secret I think about that ratio and about these mixes in asset classes is that they're never fixed. It's never just a stable 60% and 40% your whole investing lifetime. As a younger investor, it's usually considered a little more prudent to take more risk in equities because you can weather more downturns, weather more the business cycles, but participate in more upside. Ideally, someone with perfect ability to kind of hold a portfolio, you get so much better returns in equities over multiple decades that a lot of advisors look at and really high equity allocations for younger investors. And, conversely, when someone's at retirement or thereafter and they really need that income -- or they need to cash out parts of their portfolio, going incredibly conservative into very high quality bonds actually can make some sense.

Jared Woodard: So for someone who's listening to this and they're further on in their investing career or they're thinking about time to draw on that portfolio as a source of income, some of the arguments I'm making are just not going to apply because you need that money to be basically like cash. And so you don't have to think about the next 10 or 20 years, et cetera, or even the next five years necessarily of returns. So I'm very sensitive to that and to the needs of different people across different periods of their investing career, all that to say the right answer, the right mix of different asset classes and different forms of risk depends a lot on where you are, what your needs are. And that's one reason why we lean so heavily on our investment advisors to help guide people through that.

Sandy Block: I think the 60-40 mix, you're absolutely right, Jared -- but I think for a lot of people going into retirement, they're comfortable with that. And whatever mix you choose, I wonder given the outlook that you've spelled out, what about equities? Are you suggesting a different mix on that side? People should be thinking differently about the types of equities, of types of stocks they invest in?

Jared Woodard: I think there's a couple of things that are worth doing. One is to be really thoughtful about what regions of the world you invest in. It's very common to say, "Well, you just buy the whole global equity market." For example, let's just splash the money around the world in equities, and assume that diversification will work its magic. There's some really clear evidence that economic growth, and therefore market returns in some parts of the world are having a tough time and may continue to have a tough time in the foreseeable future. The U.S. is on pretty good footing. Europe and Japan have struggled for quite a while, and our economists and our team suggest that without some really major policy changes, they may continue to struggle. And so we actually are a little bit less eager to have folks allocate to some of those other developed markets.

Jared Woodard: However, in emerging markets, especially emerging markets outside of China, there's some really good arguments for investing for the long term in a way that can capture a lot of value that's hard to find in U.S. stocks today. So I think that some regions are much more attractive than others within equities, and by the same token, some sectors and some themes are more attractive than others. Value investing has just come off of the worst decade on record relative to growth. We have data back to the 1920s, and we can't find a period in which over 10 years, value lagged growth by as much as it has today.

Jared Woodard: I think that's partly reflective of some fundamental changes in the economy. And so it's worth thinking about some of those long-term themes and whether the rationale for them may have changed -- sectors like energy or materials or even some financials may be really challenged without a significant shift in the economy. And that's why we've done so much work this year on how to invest differently from a value perspective. I think these kinds of shifts with inequities, they're always happening, but the bottom line for a lot of investors is that diversification is great, minimizing costs is great, but those are not the only things that matter. Avoiding some of the real traps, whether they're value traps in sectors, value traps in regions can help investors, I think, boost their returns without really adding any incremental risk.

David Muhlbaum: Jared, I want to thank you very much for your insights, but before we let you go, I want to ask you a little bit about how you come up with those insights. And I've got to ask, you have multiple graduate degrees in philosophy and theology, a doctorate in philosophy from Fordham, in fact. I appreciate there's a mathematical connection between this background and what you do now, but can you shed a little more light on that?

Jared Woodard: Yeah. I mean, you're right. There is, you do in philosophy that you work on formal logic. I did some work in philosophy of mathematics. And so that's certainly relevant from an analytical point of view, but I have to tell you, I think that the most valuable part of my background is actually the emphasis on flexibility and creativity that is actually so important in fields like philosophy. You have to be willing to let go of your prior assumptions and your biases as much as you can, if you're going to find good arguments and try to find the truth. And that's ultimately I think what we're all after in some form. And so I think that's been really helpful for me I think, being willing to let go of official dogmas of investing or economics, and just try to find the truth wherever I can in whatever way I can, I get that kind of flexibility when you spend all day thinking big philosophical thoughts. And in that regard, I guess my background has been really helpful.

David Muhlbaum: So the truth will set you free and bring you good returns too, okay.

Jared Woodard: Exactly.

David Muhlbaum: You know what I got cooling here on my desk today? A big steaming mug of pumpkin spice latte. I know it's like 75 degrees out here in the mid-Atlantic, but I felt seasonally obligated, also because I want to talk a little bit more about the pumpkin spice economy.

Sandy Block: Okay. Do you really drink that stuff?

David Muhlbaum: Oh God, no, I hate it. Black tea brewed, really strong, one Splenda. That's my go-to year round.

Sandy Block: Okay, all right -- and I agree with you. Not a fan, but what's up with the pumpkin spice economy?

David Muhlbaum: Yeah, the pumpkin spice economy, I just like saying that. Okay, so the personal finance outfit Magnified Money went to town on this seasonal seasoning. They collect data on what they call the pumpkin spice tax. They have been doing so for some years, actually. Basically they're doing a price comparison, looking at a bunch of outlets . . . Trader Joe's, Walmart, Dunkin Donuts. And they're looking at products that differ simply by being pumpkin flavored and the average premium -- what they call a tax -- is 8.8%.

Sandy Block: So a regular latte versus a pumpkin spice latte?

David Muhlbaum: Well, yeah, right. No, that's the obvious comparison, but of course there's a specific for that. So the 8.8% is the overall pumpkin spice tax. So at Starbucks, for example, for the latte that I'm not drinking, a 16-ounce, pumpkin spice latte.

Sandy Block: A grande, okay.

David Muhlbaum: Yes, a grande. You've got the lingo.

Sandy Block: I've been there a few times.

David Muhlbaum:: A 16-ounce grande pumpkin spice latte was $1 more than one without the pumpkin, sin calabaza. So on a per ounce basis, that's 21.5% more for PSL than regular.

Sandy Block: So, that doesn't seem so crazy.

David Muhlbaum: Yeah. Okay. But so let's say you go to Walmart and you get the house brand Great Value complete buttermilk pancake and waffle mix in the 32-ounce package. You'll pay almost exactly the same as the 16-ounce Great Value complete pumpkin spice buttermilk pancake and waffle mix. You get twice as much for the same price if you can live without the aroma of pumpkin spice.

Sandy Block: Okay. But that's not an ideal comparison, because products like pancake mix are almost always cheaper when you buy the big ones.

David Muhlbaum: Yeah, you're absolutely right there, value shopper. I mean, this kind of study is not going to create a new line in the Consumer Price Index. Also it's possible maybe that pumpkin spice is somewhat over. The Magnify Money people also dug into search data from Google Analytics and they saw that searches for pumpkin spice and pumpkin spice latte did not reach the peak they did in 2018 for this year.

Sandy Block: You know . . . maybe we're in the midst of a pandemic and a recession. Maybe people are wising up to the fact that you can just go out and get your own cinnamon, nutmeg, ginger and cloves and add that yourself. And if that's too complicated, you could probably buy a bottle of pumpkin spice flavoring for a couple bucks and just make your own fancy drinks.

David Muhlbaum: Or sprinkle it on everything.

Sandy Block: Pumpkin spice potato chips -- man, they're a thing.

David Muhlbaum: Not eating that, either. Great value shopping works, Sandy. Thank you.

Sandy Block: All the time.

David Muhlbaum: And that will just about do it for this episode of Your Money's Worth. I hope you enjoyed it. For show notes and more great Kiplinger content on the topics we discussed on today's show, visit Kiplinger.com/podcast. You can stay connected with us on Twitter, Facebook or by emailing us at podcast@kiplinger.com. And if you liked Your Money's Worth, please remember to subscribe and most importantly, rate and review us wherever you get your podcast. Thanks for listening.

Links and resources mentioned in this episode:

• 8 Things You Must Know About Retiring to the Carolinas
• How Snowbirds Can Be Taxed as a Florida Resident
• Kiplinger's Retirement Tax Map
• MagnifyMoney.com: Pumpkin Spice Tax Study