-Learn the role of bonds in a balanced portfolio. -Discover whether investors need to have more risk in their asset mix. -Understand the importance of aligning investment strategies with personal goals and risk tolerance.
The 60-40 portfolio has been a go-to investment strategy for decades. Unfortunately, it encountered a major setback in 2022, with stocks and bonds experiencing substantial losses.
Persistently low interest rates and market unpredictability are complicating today's financial landscape, in turn igniting a debate regarding the relevance of the 60-40 model. In this episode, David Wong, Managing Director and Head of Total Investment Solutions with CIBC Asset Management, shares insights on how to achieve a balance between stability and growth.
Carissa: Welcome to Smart Advice, a podcast bringing you financial advice, investment strategies, and economic trends. I am CIBC's financial advice expert, Carissa Lucreziano, and today we're gonna talk about something a lot of investors are thinking about: “What is the appropriate asset mix of investments for my portfolio?” After all, it is one of the main factors that leads to your overall return. Over the last year, we've seen a lot of ups and downs in the market, and this has caused many Canadians to take a good look at how they're putting their money to work. When it comes to investing, there are some classic approaches that have stood the test of time. One of them is the 60-40 balanced portfolio model, which we all know and love, and likely a strategy many of us use and follow in our own investment portfolio.
This strategy suggests that we should strive for a mix of 60% stocks and 40% bonds to balance growth and stability in our portfolios. As we contend with higher interest rates and inflation, many investors have been wondering if this investment strategy is a thing of the past. From the Globe and Mail to the Wall Street Journal, this is a topic everyone is talking about today. We're gonna uncover the thinking in the current environment on this topic. Should your portfolio asset mix look any different? Should we be thinking any differently after such a rough year for both stocks and bonds in 2022? And how are we evolving beyond the 60-40 portfolio?
Joining me today on this hot investing topic is David Wong, Managing Director and Head of Total Investment Solutions with CIBC Asset Management. David has a deep knowledge of traditional and alternative investments, and he has cultivated this over a 20 year career as an analyst, portfolio manager and investment executive. David is known for his thoughtful approach to asset allocation and intense investment research, so we've got exactly the right person for today's conversation. David, thank you so much for joining me today for this really important topic.
David: Thank you, Carissa. My pleasure to be here.
Carissa: Yes, and I'm looking forward to your insights. You could probably talk about this topic for hours, but let's get right into it. 2022, as we know, was the only year in the last 95 years of US market history where stocks and bonds were both down by over 10%. And in Canada bonds were also down by over 10%. We are so accustomed to negative correlation between this relationship of stocks and bonds and last year had our head spinning and looking at the markets today, avid, I think we're still a little bit dizzy. So, you know, has this market mayhem prompted any changes in how you are thinking about the traditional 60- 40 asset mix? If we have to rethink this going forward, how are we gonna achieve this balance of stability and growth?
David: Yeah. Great, great questions. First of all, good riddance to 2022. I don't think there's any investor that relishes the memory of it. Look, while it's tempting to really look at the unusual nature of 2022 and extrapolate that into the future, in reality, the prospects for diversification potential inside of a managed solution or a balanced portfolio, hasn't been this bright in a very, very long time.
So the negative bond returns in 2022 actually makes the math very compelling for bond returns in the future, given a much higher starting yield. This very much benefits the return and diversification potential of bonds inside of an asset mix. We've started to see certainly that in the recent choppy markets here as we sit mid-March, as you noted on the volatility front, the rewards from uh, holding onto bonds have been present once again.
And so bonds are a countercyclical asset, meaning that they tend to do better when equities falter during economic downturns and when yields were already low for a very long time, as we all remember, there wasn't much room for them to go much lower than they were. And so the positive price movement that usually offsets the downturn in equities is greatly diminished when yields are lower.
Now, there's other reasons to hold onto bonds even in that environment, but that's a bit of a separate topic for another. Today, however, with 10-year government in Canada, bond yields at 2.85% and yields have been moving around pretty wildly lately. But the trend on yield has been lower since the start of the year, but even at 2.85%, there's lots of room for rates to decline and bond prices to correspondingly increase should we hit a soft patch in the economy.
Yields haven't been at these levels in well over a decade, so there's really good reason to be positive about the future for balanced portfolios. Now of course, lots of things can happen to introduce volatility into how the market will continue to price bonds and stocks, especially in the near term.
But we take great comfort in the long term data, which encompasses the Great Depression, encompasses two world wars, encompasses the end of the gold standard for the US dollar. We've had inflation problems in the past in the 1970s and early 1980s, and we've had a global financial crisis in the last 20 years.
All of these things have happened in the past, and there's never been to this point a 20 year period where equity returns or bond returns, for that matter, have been negative for that entire timeframe. So financial markets are resilient over the long term. It's important to remember this from a first principals basis rather than just looking at it as a mythical kind of 60-40 mix.
At the end of the day, the returns are rooted in investing in a diversified mix of businesses and staple governments. So these are not speculations into risky concepts. It's real financially productive assets that are being invested in. And just to be clear, like there is room always to improve on a 60-40.
So at the margins we could include things like alternatives, which can provide some volatility reduction at the margins. But by and large, we're not negative on the prospects for 60-40. And if. The facts really line up for some positive outcomes for 60-40 in the future.
Carissa: So David, you mentioned long-term and the outlook seems very promising and confident, but when we think about achieving long-term goals, investment growth is vital, like buying a cottage, enjoying retirement with surplus cash flow, purchasing investment properties, — we know how much a down payment is these days. And, you know, just building a set amount of wealth to sustain lifestyle.
Should Canadians be rethinking their portfolio asset mix, you know, adding a little bit more growth to their overall portfolio mix, especially if they have 10 to 20 years?
David: Yeah. Really important questions. And it always starts with the client need. I think that sometimes gets lost in the mix of just thinking about asset mixes in general. Really what we should be asking is what is the timeframe of the investor? How long until that retirement, or how long until the need for the cottage, right?
How much does the investor already have saved? All these things are really, really important. What type of lifestyle does an investor want in retirement? So these questions and these answers give us, you know, indications of the willingness and the ability of an individual client to take on investment risk.
And it also tells us the return profile that's needed to help our clients realize the ambition that they have. So there are no crystal balls investing. Just to be clear, I don't have one, no matter how much study I put into the markets or the economy, but we do know that risk that is related to financial productivity that is diversified tends to be rewarded over the long term.
It's, as I mentioned earlier, it's never failed over the very long term. But how do we actually help investors enjoy that? I think that's a really important challenge that we have, and I've got some data to kind of support what the challenge is and some promising comments around how to actually solve for that.
But we know in the short term, there is volatility in the markets, and when investors are undiversified, some very bad decisions can occur. Morningstar runs a study every year on something called the investor behavior gap. It's a very important topic for all investors. And what it is, is it's really the difference between the returns of mutual funds and the returns of the investors in those mutual funds, which are different actually it's a little confounding, but they are actually different and it's due to, in part, the buy high and sell low behaviors of individual investors.
Now, over the past 10 years, the gap for US equity investors, is 119 basis points, meaning that mutual funds and the investors in those mutual funds have a difference in return of 119 basis points, which disfavors the mutual fund investor and again, due in part, to buying high and selling low.
For investors in balanced funds, so when we diversify that mix, that gap is actually significantly lower. It's only 77 basis points, so it's not perfect, but it's better than being undiversified. So we tend to reduce the worst tendencies of investors when we diversify. Now, a 100% equity portfolio is very likely to outperform a balanced portfolio over the long term.
I think that's, uh, pretty clear to most, uh, investors. But the data simply tells us that a balanced fund does a better job of keeping investors invested. And the reason for that, again, if you look into the data, you know, a 60-40 portfolio, and it could be any mix, right? Like that's just the shorthand for balanced portfolio or diversified portfolio, including bonds and stocks.
It really could be any mix that provides a smoother ride than just pure equities, right? You lower your volatility, you can look at any five-year timeframe, and you'll see lower volatility for a 60-40 mix versus an all equity mix. And that includes the last five years, which as you talked about at the outset, includes a pretty choppy, uh, environment for 60-40.
And so over the past 47 years, it's not just about getting lower risk from a balanced portfolio. You actually get a more efficient portfolio. Over the past 47 years, you would've received one unit of return for every one unit of risk in a 60-40 portfolio of US equity and US bonds. Whereas if you were an all equity investor, you would've only received 0.75 units of return for every one unit of risk.
So by diversifying your assets in an asset mix, you get a more efficient return profile. That's what helps investors stay invested and, you know, better enjoy the compounding benefits of financial markets rather than succumbing to those fears, you know, doing the worst possible thing at the worst possible time.
And you know, 60-40 is a rule of thumb. It's been viewed a little bit skeptically in the financial media over the last several years. But it really doesn't speak to the specifics, right? It's easy to say 60% equities, 40% bonds, but what are equities and what are bonds?
There are 23 developed countries in the equity markets. There's 24 emerging countries in the emerging markets. Part of the equity markets, there's a whole spectrum between small cap and large cap. There's a whole spectrum between value investing and growth investing. Inside of the bond markets, there's many different ways to invest in bonds. There's government bonds, provincial bonds, corporate bonds, et cetera.
And so the more granular we can get in that asset mix, the more we can get better potential reward-to-risk in our portfolio.
Carissa: Yeah, very compelling insights. And you know, you talked about the fundamentals of investing, diversification and you've made a lot of great points around, you know, the behaviors to investing and it has a huge, huge impact on overall returns and the wealth that you can build over the long term.
You started to talk a little bit about further diversifying that 60-40 or that balanced portfolio. You know, I'll just end off with this, I guess, question to you. We're seeing this topic of reevaluating your portfolios everywhere, like recent Morningstar article titles. You know, Don't Lose Faith In The 60-40 Portfolio, Bloomberg: Will The 60-40 Portfolio Stage A Comeback? and Forbes, The 60-40 Is Going To Have A Horrendous Year. You know, some experts are even suggesting go more growth and think about 70-30.
But putting that aside, just for a moment, if you think about maybe the behaviors, and you alluded to it just now about how do we have to think about investing differently or further diversifying within that 60-40, how do you suggest that the investor approach that and, and what are some of the things that they should look for?
David: Yeah, there needs to be a lot more flexibility, I think, around asset mixes or thinking about asset mixes in general. You know, certainly over the last decade we've seen multiples, PE multiples get higher and higher, which does not portend well to future equity returns.
We've seen that correct a little bit through the recent environment, which is more promising for returns into the future and bond yields correspondingly very similar kind of observations. And so having just those rule of thumbs I think can be a dangerous thing, right. Just thinking about, you know, having 120 minus your age as the new starting point can make sense in a, maybe a lower return environment.
And if you have a financial ambition that you need to get to, there might be the need to accept more risk or the need to accept kind of a different end target in mind, right? So we need to not think of the asset mix as the end, but the means to the end. And so that's very important. And I think from a starting point, having more risk in the portfolio is something that I think investors need to explore a little bit more fully.
It can be an uncomfortable discussion, certainly in the short term, but again, the long term facts do support the equity risk premium definitely being rewarding for investors. And at the same time, we've got a good problem in the sense that lives are getting longer, certainly in developed economies, so that is something for all of us to take away and, and certainly, uh, provide that food for thought with.
Carissa: David, thanks for sharing these insights on one of the most important decisions in investing for the long-term: setting the asset mix of your portfolio. A lot of this thinking about asset mix is for the long term investments, 10 to 20 years or longer.
From this perspective, we have to be careful not to get too carried away by one year, like 2022. Patience and purposefulness are important qualities to bring to investing, not just in setting the asset mix, but being able to stay the course to achieve your long-term goals. Thanks for tuning in to this episode of Smart Advice.
To make sure you never miss an episode, subscribe or follow on your favorite podcast platform, and visit us for more advice at cibc.com/smartadvice. Thanks for listening.