In the Wall Street Journal yesterday, James Mackintosh put up the following chart:
I don't get it. Why would you deliberately put up a chart that ignores inflation? It's like ignoring the law of gravity. "If you don't count the effect of gravity, our plane is ascending nicely. Oops."
Here is the 20-year total return for a 60-40 fund based on the numbers in the chart above:
It looks good! Until you account for inflation, that is. Once you do that it's never more than barely above an S&P index fund, and mostly well below it.
Do you even need a chart to tell you that? In general, bonds have less variability than equities, so they'll do better when stocks are going down, and worse when stocks are going up. It's portfolio selection 101.
That's not true for 2022.
At 3:50 of the video here, the chart tracks returns for stocks and bonds since 1871, and 2022 was the worst year ever.
https://www.ccmmarketmodel.com/short-takes/new-bull-market-leaders
The rule of thumb is that stocks are risk-on, bonds risk-off, and there are plenty of times that works. But there are plenty of times it doesn't. Stocks and bonds can move together, up or down.
If you look at long-term returns for stocks and bonds, stocks perform better. If you want to maximize returns, weight your portfolio heavily or entirely in stocks. The reason bonds are popular, as in 60/40 portfolios, is to minimize some of the wild swings of stock returns. It makes it easier to SWAT (sleep well at night). Good investing is not just about maximizing returns. A lot of it's about psychology.
But 60/40 had a terrible year. Question is if that was just an outlier, or a trend of what's to come.
(I've never been a fan of 60/40, but that's just me. It usually works fine for lots of people.)
The mix for return is also affected by tax policies: capital gains vs income.
Total bond index was down 13% in 2022, while the S&P was down 20%. A 60-40 mix would be somewhere in between. So even then, bonds did better (were down less) when stocks were falling. Our host didn't consider taxes, so I don't either. I'll admit there may be exceptions to the rule.
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The comparison between the 60/40 stock/bond and 100% stock (S&P 500) investments has nothing directly to do with inflation, but a lot to do with interest rates. As interest rates were low after 2008, money flowed to the stock market, so the 100% stock investment did much better. Now as interest rates have risen, stock prices have gone down, but so have the values of bond holdings. If interest rates remain high stock prices can be expected to drop further, as they did up to 1981. Bond returns (on new purchases) will be higher. Near the end of 2021 as both stock and bond prices were very high the prospects for future gains looked poor. If recent trends continue there may be a time in the near future when prices of both are low as they were around 1982. That will be the time to invest your millions - we're all gonna get rich.
Over time the market rewards you for taking more risk (S&P 500 index fund v. a 60/40 portfolio) Over shorter periods taking lower risk protects you from volatility. Choose your poison.
Folks of my age should be interested in capitol preservation not max ROI. I keep harping on that to the wife. She is a young whippersnapper. Does she listen?
Back in 2009 after selling the house we bought rentals in Reno. This was from a recommendation of a good friend. Those rentals have done well. Later we learned our friend had sold her Reno rentals and bought bonds.
It took time to get the wife to get the hell out of managed funds and put it all in Vanguard. The managed funds eat all the gains in fees.
Why would you deliberately put up a chart that ignores inflation?
Because it is the WSJ, and the likelihood of them saying investing doesn't pay off is similar to the odds of hearing the Pope promote sex parties.
Just a general note--how are stock prices set?
With a lot of money in index funds, then stocks get a big jump if they make into the index since everyone has to buy them. They'll also drop a lot if they fall out of the index and everyone sells. But who is trading those stocks when they are not part of the Dow or listed in the S&P500? To get an accurate price, you'll need a number of actively managed accounts, with analysts, etc., doing background work, product evaluation, etc.
Adjusting for inflation doesn't make the reader any more informed in this case.
Adjusting everything for inflation can be fun, but isn't always a value add.
I'm missing the point. Even if you didn't adjust for inflation, wouldn't S&P500 outperform, anyway?
Bonds are theoretically to reduce the volatility, not to improve the performance. Many studies show that almost nothing beats the longterm gains of the S&P 500 so put most of your money in a broad-based mutual fund and just ignore it. Regardless of inflation very few longterm investments will beat it, and you don't have to do anything.
Well, obviously a 100% stock portfolio will outperform a 60/40 portfolio; everyone knows that (or, to be more precise, everyone knows that has been the case in the past). As the headline on the chart notes, the matter at issue is whether 60/40 portfolios are less vulnerable to large short-term losses. It is a claim about volatility, not long-term gains.
Trump's tax cut for the uber rich and relatively cheap money really did send the stock market into bubblicious territory.
Of course capital gains vs income comes into play.
Only took a pandemic and Fed hiking up rates to get stocks to start to drop back to Earth.
As for the difference seen between inflation corrected 60:40 and S&P500, not much until end of Obama years--some of that was the economy finally fully recovering after 2008. Trump's tax cuts then sent things up, though P/E was shooting up too. Talk about irrational exuberance
Note: Boomers are retiring in droves and that pulls money out of 401K's and the market in general. Older articles have net outflows exceeding inflows since 2013, but market still going up. Probably artifact of top 10% owning everything.
Are you serious?
Why ignore inflation?
Because we do it ALL THE TIME.
What is the price of Tesla today? What was it last year? How much did it go up or down? When has anyone EVER said well it is down 66.81% but that is 68.8% after inflation? NEVER
What was the price of gold 10 years ago? I can look it up.
What was it after inflation? I would have to calculate it because nobody posts those numbers.
Kevin, you have jumped the shark on this one.
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What is the offending chart trying to show? The caption tells: "Big Losses are rare for [the] 60/40 [portfolio]" So, the chart is showing the annual gain or loss for the 60/40 portfolio NOT cummulative returns. Therefore, inflation is actually irrelevant to the comparison. Your chart shows cummulative returns. Apples v. Orangutans. All other comments regarding the 60/40 may be relevant to it's value as an investment. However, the chart which is being criticized simply shows the yearly gain or loss. And, losses are relatively rare, which is no consolation to someone holding the portfolio in 2022.
I think you've got this wrong (and Kevin's right). Kevin chose to highlight or accentuate the inanity of WSJ's approach by showing cumulative returns, true! But cumulative returns are simply year-after-year-after-after year of annual returns—aggregated. And even for an annual return you still want real (inflation-adjusted) figures. At least I do. A fund that gave me a nominal 6% return in a particular year isn't much to write home about if inflation was up 10% that same year.
My point is simply that the chart fulfills its purpose and inflation is not relevant to that purpose. Critiquing the chart for doing its stated purpose is really just changing the topic. Full Stop.
Drawdown risk is just one of many factors, including inflation adjusted long term returns, that are relevant to investing decisions. Declaring one factor inane because it doesn't address one investing goal is not a productive analysis. Persons with a different set of goals would find it quite relevant. It is not a zero sum decision. Consider the full range of decisions and where the two offered pieces of information plus others fit into a whole.
Since Murdoch bought that paper I reckon the median cognitive capacity of its readership has declined. And editors are chosen not on their ability to create strong journalism but to serve The Party.
There is an implicit comparison to other mixes during the same time period. When using the same time series adjusting for inflation is not terribly important because it will affect all assets equally. The exception being perhaps Treasury Inflation Protected Securities (TIPS) although they still have a real dollar rate of return like anything else.