Why Bonds? Explaining Their Role in a Portfolio
The Different Types of Bonds and Their Role in a Diversified Portfolio
Recently, the call for the death of the 60/40 due to the recent poor performance of bonds. In fact, there has been a research paper, Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice, that has called into questions the typical glide path and even has some strong arguments staying at 100% stocks all the way through retirement.
However, shockingly, even with the poor performance of of bonds, the traditinoal 60/40 has continue to work great for those going into retirement.
📈 Performance Overview (2015–2024)
Annualized Return: Approximately 7.24%
Standard Deviation (Volatility): Around 8.43%
Maximum Drawdown: -18.91%
Sharpe Ratio: 0.72
***Date was pulled
These figures suggest that the 60/40 portfolio has provided moderate returns with relatively low volatility compared to equities alone. However, the maximum drawdown indicates that investors have faced significant losses during market downturns.
📊 Year-by-Year Highlights
2015: Return of 1.21%
2016: Return of 6.53%
2017: Return of 10.86%
2018: Return of -1.39%
2019: Return of 17.62%
2020: Return of 13.39%
2021: Return of 9.65%
2022: Return of -14.64%
2023: Return of 13.75%
2024: Return of 10.76%
The portfolio's performance has been notably strong in years like 2019 and 2020, but it also faced challenges in 2018 and 2022, reflecting the impact of market volatility on balanced portfolios. Over a ten year timeline, it had two negative years with equities providing most of the Rate of Return (ROR). Furthermore, it is important to be properly diversified between the different ypers
🔍 Comparative Analysis
When compared to other investment strategies, the 60/40 portfolio has generally offered a balance between risk and return. For instance, during the same period, the Ray Dalio All Weather Portfolio, which diversifies across asset classes, has had a slightly lower annualized return but with reduced volatility and draw downs.
Furthermore, it is important to understand different type of bonds have different levels of risk. One needs to be properly diversified between the Corporate, US treasury, etc. bonds.
🧠 Considerations for Investors
While the 60/40 portfolio has been a staple for conservative investors, it's important to note that in recent years, both stocks and bonds have faced challenges simultaneously. This has led to reconsideration of traditional asset allocations. Some experts suggest increasing diversification within the portfolio by incorporating international equities, commodities, or other asset classes to mitigate risks associated with market downturns. While, I caution major commodities, for long timelines, it does have some evidence it helps lower overall volatility.
Conclusion
In the world of academic research, the traditional 60/40 stock to bond portfolio has come under attack. There has been some interesting research and papers outline the aggressive 100% stock market approach throughout retirement. With some strong evidence it is likely to out perform over long periods. However, it requires one to have flexible to decrease spending when equities decrease in value and increase spending when equities are up is necessary. Along with assumption that your equity is diversified across international stocks and real estate.
In summary, the 60/40 portfolio has provided steady returns with moderate volatility since 2015 and continues to work well for those following a general guide of 4% distributions. However, investors should remain mindful of its limitations and consider adjustments based on evolving market conditions and individual risk tolerances. Bonds and annuities, can give you more certainty in what you can spend and less reliance on the market. Coming back to the age old discussion of risk versus reward.
Author:
James Hargrave, MBA, CFPⓇ, CLUⓇ,