Why the 60/40 Stock/Bond Portfolio Could Ruin You. Think Cycle Dynamics.

March 20, 2017

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Why The 60/40 Stock/Bond Portfolio Could Ruin You. Think Cycle Dynamics.

We will only prosper if we relentlessly search for the truth, otherwise the truth will find us through volatility.” – Chris Cole

Financial advisers have recommended for decades that investors put 60% of their money in stocks and 40% in bonds. People assume the safety and stability of bonds will protect you when stock prices fall.

But taking this tired advice could ruin you.

Chris Cole at Artemis Capital – a hedge fund that specializes in volatility investing – busted the Wall Street “60/40 stock/bond” myth in an October 2015 research report called “Volatility and the Allegory of the Prisoner’s Dilemma.” The insights are more timely today than when they were originally published.


Too many people believe stock and bond returns correlate negatively, meaning they can be relied upon to move in opposite directions. Cole looked at more than 132 years of data and discovered this correlation myth is false.

Cole writes, “The truth about the historical relationship between stocks and bonds is scary.”

Using rolling three-year stock and bond price data (a standardized metric) from 1885 through 2015, Artemis discovered that stock and bond prices have historically moved in the same direction roughly 70% of the time and in the opposite direction just 30% of the time.

Artemis says it’s only during the last two decades of falling interest rates and accommodative monetary policy that stocks and bonds have been negatively correlated. Otherwise, the firm reports, “Not only are stocks and bonds positively correlated most of the time but also there is a precedent for multi-year periods whereby both have declined.”

This might seem like a purely academic topic. Even Artemis admits the last 20 years have been pretty good, with bonds protecting investors when stocks sank.

But that’s exactly the type of thinking that had investors in the early 2000s repeating that “housing prices have never experienced an annual decline”… right up until the housing bubble blew up, spectacularly destroying a substantial portion of the value of all the housing- and mortgage-related products Wall Street had successfully peddled in the prior years, pushing the S&P 500 down.

Maybe there was an excuse for believing housing would never decline because it had never happened before.

But nobody has any excuse for believing stock and bond prices can’t fall at the same time because that’s what has happened 70% of the time going all the way back to 1885!

This myth that the stock/bond split is risk management seems highly prevalent, but it is clearly very poorly thought out. Fortunately, there is a better approach that can move disillusioned investors on to much firmer ground.

Perhaps investors could use a more universal and better time tested perspective – Cycle Dynamics

All you have to do is start thinking about cycles, and cycle dynamics. Broadly speaking one of 4 main economics conditions will prevail at any one time.

Ray Dalio of Bridgewater, the world’s biggest hedge fund, introduced cycle theory to investment management back in the 1970s and the charts in the link below show how effective his all weather system can be in the very long term. This line of thinking can go so much further.

The evolution is quite straightforward and laid out in a simple way in the link below.

Passive Cycle Dynamics. 2 Simple Investment Transformations.

The bottom line for investors is that if the best your advisor can come up with for your portfolio allocation is a split between stocks and bonds, you should now know how limited and dangerous that could be.

If your advisor can not improve on that advice then you may need a new start before volatility finds you.

Of the 4 conditions that can exist in the economic cycle, it is just a matter of time before stagflation cycles round again. How will your stock/bond split do then? How well did it do in the 1970s?

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