A lifetime of Income from The Classic 60/40 Asset Allocation
In recent years financial pundits have declared that the 60/40 portfolio is officially dead and can no longer provide a stable stream of income from its component parts, 60% stocks and 40% bonds. The rationale behind declaring the death of this commonly used allocation is that bond yields are so low that allocating 40% of your portfolio to this asset class would not deliver the necessary income needed. Also, with interest rates at historic lows, total returns on bond funds would have nowhere to go but down as interest rates would have to rise going forward providing little in the way of capital appreciation from any bonds held in your portfolio. Sounds reasonable but what happens to the equity side of the portfolio in consistently low interest rate environments? These periods, followed by a rise in interest rates, result in little capital appreciation or total return in the bond portion of the 60/40 portfolio.
In these cases, equities tend to perform above their historical averages making up for the deficient performance of the bond fund. The absolute worst performance for bond funds over a ten-year period was about a .5% from 1950-1959. Over the same period, the 60/40 portfolio returned 12.4% which exceeds the average return for 60/40 portfolios with a 10-year holding period by over 3.5%. The equity portion of the portfolio delivered a total return of 19.4% from 1950-1959 making up for the lack luster bond performance. Over longer 40-year holding periods, the equity side of the 60/40 portfolio has delivered returns in the 70th percentile when total returns on bonds were at historic lows. This is true for 20-, 25-, and 30-year holding periods as well. Again, equities made up for lackluster bond performance. However, the most crucial point is that financial pundits do not know what the future holds, and the best predictor of the future is to look to the past for answers. As stated in previous writings, history does not repeat itself, but it rhymes, producing comparable results but for varied reasons.
The 60/40 portfolio is just as relevant today as it was 50 years ago. The real issue is determining the appropriate withdrawal rate to generate the most stable income stream over an extended period of time, and at Investoristics we would suggest a 40-year period. Historically, 60/40 portfolios have delivered returns ranging from a low of 7.14% to a high of 11.63% with the average being 9.68% over 40 years. Investors should look to determine a breakeven withdrawal rate which generates a stable income flow while preserving their initial capital at the end of the 40-year period. In our example we will assume that an investor will be able to generate an average return of 9.68% over the next 40 years with hopes of a lifelong income.
Let us assume that you have an initial investment of $500,000 and would like to generate the highest and most consistent level of income over the next 40 years while preserving your initial investment. We will use actual returns from a prior 40-year period so that you can experience actual market volatility. After doing the math we have determined a breakeven withdrawal rate of 9.05%. If you were to withdraw 9.05% from your investments starting a year after your initial investment, your average income for the 40-year period would have been $40,500 per year with a low of about $25,000 when markets move against you. Your initial principal after the 40-year period would still be intact.
However, most investors would be looking to grow their assets while generating a stable stream of income. In that case, a 6% withdrawal rate would be optimal, providing an average income over the period of about $52, 000 per year with a low of about $32,000. Your balance after 40 years is about $1.8 million. This withdrawal rate would be sufficient for a lifetime with a steadily rising income. Of course, using the Investoristics 10 as your equity portfolio of choice over the S&P 500 in the 60/40 portfolio, you would have a much higher and more stable income over the 40-year period with a final balance well beyond the $1.8 million used in our example and a much higher future income for generations to come.
Consider joining “The Collective” to breathe life into your classic 60/40 portfolio, if you think it is dead. Our Investoristics 10 provides all you will need to stabilize and increase your income over time as it provides significantly higher returns with a lower risk profile.
