A 60/40 Stock/Nonstock Allocation

Aug. 8, 2003
© 2003 Tom Madell, Ph.D.

Many investors continue to believe that the future is so totally unpredictable that no current economic data nor discusion of past fund performance can make much difference regarding their future success vs. potential subsequent underperformance as an investor. To this I have a simple reply: Bunk!

While one cannot count on predictions for the future, a careful analysis of present and past financial information can generate higher odds of success than not making or considering any predictions at all. Disavowal of any predictions probably leads to a success rate of 50% success/50% non-success versus other investors and other potential investments. Careful predictions, on the other hand, made from reliable information or coming from a source with a good track record can hopefully lift that success rate up to as high as 67% success/33% non-success. I shouldn't have to point out that such an increment will generally translate into thousands and thousands of dollars a year, depending on how much you are investing, but most people routinely fail to realize this.

So what can be said about the future now? Although it is hard to make such generalizations, it is often thought that the "typical" investor should allocate 60% of his investments to stocks/stock funds, and the remaining 40% to non-stock investments. Perhaps a good framework when applied on a fairly long term basis. Anyone who maintained such an allocation over the last 10 or more years has probably not regretted it as compared to someone who was significantly more conservative.

But in fact, most investors did not really maintain such an allocation during recent years. Rather, most tended to be more highly invested in stocks, especially toward the end of the last decade and even into the beginning of this one. In some cases, they may have started at 60% stocks, but then failed to re-balance to 60% when this asset category was advancing far in excess of their nonstock investments. In other cases, they, like most, assumed that stocks would continuously outperform any other asset category.

Unfortunately though, the 5 year returns of the typical stock fund have been less than stellar during this period. In fact, in spite of all the recent gains, the average large blend fund has returned an annualized -1.1% over this period as of 8-7-03. Thus, the higher one's allocation to stocks during this period, the worse they have tended to do versus those in non-stock investments. And the more one realized that technology and large growth stocks were not the place to be during this period, the better you would have done also. Bonds, small stocks, and real estate were some of the areas that would have been far better choices based on the kind of research I was doing.

While diverging lower from a 60% or more allocation to stocks has paid off during the last half dozen or so years (S&P 500 at 951 on Aug 7. 1997; at 974 exactly 6 years later, for a total price gain (non-annualized) of a mere +2.4% ), we believe that 60/40 formula is starting to make more sense again.

One of the main reasons is because most of the alternatives to stocks now no longer appear to be well situated with significant opportunity to do well. Bonds no longer look especially attractive given their current low dividends and low probabilities for further appreciation in prices. Keeping cash in a money market fund does not seem appropriate either, except as a short-term holding place for moving money into temporarily depressed funds. The real estate industry and market for single family homes currently seems to be resting on shaky ground although most investors/home buyers apparently haven't noticed yet. Small stocks however, of all the previous alternatives alone, still appear to offer some attractive opportunities for outperformance.

No one can know in advance what the future will bring. But as a person committed to research for much of my adult life, I have learned that investors are far better off as a result of embracing it than taking the other path, the one that assumes that mechanical, non-changing formulas will always turn out just as well.

About the Author

Tom Madell, Ph.D. publishes free mutual fund advice at his website at http://funds-newsletter.com. His Newsletters, beginning in May, 1999, were designed for educational purposes only and are not-for-profit and ad-free. Had you been reading and following the advice on this site, you would have done far better than the cumulative negative stock market returns over the last 5 years. Tom's investment articles have been chosen as featured articles on numerous other websites.

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