After five years of strong stock market gains, investors get anxious about making up for lost time or trying to get a little further ahead by plowing more of their portfolio into stocks.  If your goal is to achieve the highest long-term returns and are comfortable with the short-term risk, an all-stock or mostly-stock allocation makes sense.  But for many others, a more balanced approach that is diversified within stocks as well as across stocks and bonds is a better way.

+8.3%

Table 1 looks at the four major market cycles in the last seven decades and the results for two different investment portfolios: an all-stock “total” market index, and a more balanced allocation that holds 65% in stocks and 35% in high-quality bonds, with the stock allocation split more evenly amongst large/small and growth/value companies.

The post-WWII bull market began in 1942 and was a boon for stocks.  Strong corporate profits and relatively benign inflation (3.1% annually) produced over 12% per year returns on stocks net of inflation.  The more diversified 65/35 allocation did fine as well, earning over 8% per year net of inflation, but did trail the all-stock index by a noticeable margin.

The good times didn’t last forever, and the mid-60s ushered in a period of economic stagnation and accelerated inflation (6.8% per year from 1966-1982).  This did not bode well for stocks, especially the large cap, blue-chip companies that dominate the US “Total” Stock Index, as returns were barely positive (+0.5% per year) net of inflation.  The more balanced 65/35 portfolio was able to survive a bit better.  The +4.1% inflation-adjusted return was only half of the previous-period result, but would have been enough to produce a healthy rising retirement income stream or modestly grow an accumulator’s real wealth.

The 80s and 90s were host to the greatest stock bull market in recent history.  The US “Total” Stock Index earned over 14% per year even after deducting 3.3% annually for inflation.  And while the diversified 65/35 mix performed well, it trailed the all-stock index by almost 3% per year.

Since 2000, broad stock indexes have once again been stuck in neutral, a pattern very reminiscent of the ‘66-’82 period.  Inflation has remained tame at only 2.4% per year since the turn of the century, but this has proved a difficult bogey to exceed.  The US “Total” Stock Index only earned 2% per year more than inflation, all of it coming in 2012 and 2013.  The more diversified 65/35 mix again has produced a more palatable result, earning almost 7% per year in excess of inflation.

Over the entire period, which covers two extended bull markets and two prolonged sideways markets, we see the US “Total” Stock Index and the 65/35 Asset Class Index produced very similar returns of about 8% per year net of inflation.  But this long-term result hides the short-term disparities.

For the US “Total” Stock Index it was hit or miss—two periods (’42-’65 and ’83-’99) saw annualized real returns almost double the long-term average, and two periods (’66-’82 and ’00-’13) produced almost no returns at all net of inflation.  Said differently, with the stock index — you either finished the race in first or you didn’t finish at all.

The slow and steady 65/35 balanced portfolio had a much different fortune.  Each period’s inflation-adjusted return was within a tight range of its long-term average, with over +4% annualized real returns on the low side and less than +12% annualized real returns on the upside.  It wasn’t always the best-performing approach, but it rarely produced regretful results.  Satisfied with not having to always come in first place, slow and steady investors, with their balanced and diversified portfolios, were happy to just finish the race in tact.

Looked over the entire period, however, it was the slow and steady investors who wound up winning the race.  When we realize the race itself wasn’t a sprint, but instead a long-term effort to earn a reasonable accumulation-period return to retire comfortably, or produce a sustainable and rising stream of income in retirement, while also achieving a positive ending portfolio balance that could be passed on to loved ones as a legacy, we see the 65/35 Asset Class Index never failed to cross the finish line.  It’s an important reminder than bears repeating: with investing, slow and steady wins the race .

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Source of data. DFA Returns 2.0

US “Total” Stock Index = 100% CRSP 1-10 Index

65/35 Asset Class Index = 19.5% S&P 500, 19.5% DFA US Large Value Index, 26% DFA US Small Value Index, 35% 5YR T-Note Index.  Rebalanced annually on Dec 31st.

Past performance is not a guarantee of future results.  There are limitations inherent in model performance; it does not reflect trading in actual accounts and may not reflect the impact that economic and market factors may have had on an advisor’s decision-making if the advisor were managing actual client money.  Model performance is hypothetical and is for illustrative purposes only.  Model performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted (which, for Servo, is 0.75% on the first $2M and 0.5% above $2M).  This content is provided for informational purposes and  is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.