Vanguard’s research division published a new report [pdf] that found that a portfolio split 50/50 between stocks and bonds had very similar inflation-adjusted returns regardless of whether the U.S. economy was growing or in recession. Here are the numbers from 1926-2009 taken from the report summary:
Given that timing recessions and expansions has been shown to be very difficult, this would suggest that making big asset allocation moves (bets, really) to 100% stocks or 100% bonds in anticipation is not worth the effort.
It also reminds me that as a portfolio asset allocation gets closer to 50/50, the swings in return each year are less wild. After 2008 and 2009, I think many people have a new appreciation for lower volatility. Maybe it would be better for many investors that don’t have full “faith” in the stock market to move their asset allocation to 60% stocks/40% bonds or similar, instead of the 80 or 90% stocks that some calculators or target-date retirement funds would suggest.
Along those same lines, Morningstar has found that most “tactical asset allocation” funds have had a hard time beating the simple-and-cheap Vanguard Balanced Index Fund (VBINX), which is basically just two index funds in a fixed 60% stock/40% bond ratio. The 10-year returns are in the top quartile of similar funds, with a below-average standard deviation.
Vanguard recently decided to kill off it’s own market timing fund, the Vanguard Asset Allocation Fund, formerly actively managed by Mellon Capital. Even a low expense ratio of 0.27% couldn’t save this one.
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Can someone help me to explain one thing? I guess I’m missing something that is obvious for everyone else.
When we are talking about “return rate” (be it for 1 year or 10 years or historic average) does the number matters at all? Until we sell our stocks we don’t realize this gain and essentially nothing changes. Why I should care that 1 year return is 7% if when I sell my stock their price will be less and so is actual return?
And from this the next thing I do not understand is the compounding interest on stocks. Is the compound interest people are talking about is coming from the small dividend payouts? What if stock does not pay dividends?
Please, help me with this one, what I’m missing?
I think the “return rate” is how much it goes up each year.
So if you put $100 in a fund and the return rate stays at 5%, after the first year it’s worth $105, the second year $105*1.05 = $110.25, third year $110.25*1.05=$115.76, etc.
Sure, but if you do not sell it you do not gain anything. So all these numbers mean nothing until you really do something with your stock, no?
Right.
So, generalizing. If I want to retire in 15 years and I have a stock for company X and this stock provides me with a good return dividend for 10 years (say 10%) but suddenly the stock price sink a lot at exactly 15 years when I want this money – I essentially screwed because all of these dividends I received have been eaten by the stock price crash (assuming automatic dividend reinvesting into the same stock)?
Why in god’s name would they use CORE CPI for this? CPI is what matters here.
I’ve argued many times that it makes perfect sense for the fed to consider only core inflation in making policy decisions (otherwise they’d be throwing the FFR all over the place all the time… raising rates in 2008 as oil prices went up, for example), but when you’re adjusting investment returns for inflation over a long period of time?? Top-line inflation, please.
@Alex – Return should be total return from the beginning to end of a given period, including capital gains (stock price) and dividends together. Specifically, these are annualized geometric returns. In your example, the dividend would count in the total return, but would be affected by the drop in share value.
For people that are young, how concerned should we really be with variance in expected outcome? What seems to be the most important to me is the asset allocation that would theoretically maximize the mean annual return, and accept the risks of higher variance. I know that these do not always go hand-in-hand (good post on this blog about that topic a few weeks ago). For me, my idea is to re-allocate to accept lower mean expected returns and lower variances as my time horizon decreases. Am I missing something?
Most of these simulations (including this one) never take into account dollar cost averaging, which has a huge impact and makes these types of simulations useless the average investor they’re designed for
@Naveen – If you have the discipline to rebalance and not change your asset allocation both in times of great fear (2008-2009) and also in times of great exuberance, then you should be fine with your plan.
But from the frantic emails that I get sometimes and even as you see the market timing leanings of professional money managers, it can be very tempting at times to shift things around. I think a takeaway from this report is that if you have a good balance between stocks and bonds, you’ll feel the need to shift much less, and it will turn out just fine in good times and bad.
@hoosierdaddy – I see your point, I look at dollar cost averaging as meaning you have many different time periods of investing all mushed together, including starting investing in recessions or expansions.
Dollar cost averaging would be of interest, but how do you set the ratio of the added funds to the original amount? Do you start with $1K and add $1k per mo? or $10k and add $1k/mo? Makes big diff. I dont know if that data can easily be extrapolated.
I need to check the Vanguard site, but the paper says they rebalanced monthly in that report. Vanguard normally freezes your account after the first sell for 90 days for some stock funds…. (a stock buy incurs as much expense as a sell so I never understood their extremism on selling in the first place, but that is another issue..). Research papers usually point to rebalancing no more than 1/yr, if not 2 yrs in a bull mkt.
You bet it does. check out my blog for an analysis on this same topic. Diversification safeguards you from unknown pitfalls.