Only once in the past 100 years have America’s long-term savers done worse than they did last year. Only in 1974 — the year of Watergate, OPEC embargoes, gas lines and recession — did the standard, benchmark, middle-of-the-road investment portfolio lose more value than it did in 2022.
That didn’t even happen in 1931, when the Wall Street crash turned into the Great Depression and a global crisis. Nor did it happen in 1941, the year of operation Barbarossa and Pearl Harbor. And not in 2008, the year of the global financial crisis.
The so-called “balanced” or “60/40” portfolio, consisting of 60% U.S. large-company stocks and 40% U.S. bonds, lost a staggering 23% of its value last year in real money (meaning when adjusted for inflation). The figure in 1974, incidentally, was only slightly worse: 24%.
This isn’t supposed to happen. The whole purpose of this “balanced” portfolio is to avoid really bad crashes. If investors were happy losing a quarter of their money in a single year they’d invest it all in stocks and expect at least to make bank down the road. The point about 60/40—the point at least sold to savers by Wall Street — is that the 40% invested in “safe” bonds is supposed to balance out the risks of the 60% invested in stocks. But last year bonds fell as much as stocks.
The real problem with 60/40 isn’t that it failed last year. It’s that it has failed before, much worse, and could do so again. That’s because 60/40 can fail over long periods of time.
Don’t believe me? Check the history files. Someone who held their money in this “balanced,” 60/40 portfolio ended up losing money in real terms for basically the entire 1960s and 1970s. If you’d invested $1,000 in this portfolio at the end of 1961 and slept for 20 years just like Rip Van Winkle — instructing your money manager to do nothing but rebalance the portfolio once a year to keep it at 60/40 — when you came back in 1981, you’d find that over that entire period your return would be essentially nothing. All your gains would have been wiped out by inflation, and then some. The purchasing power of your savings would have actually fallen slightly over that time. You’d have less than you started with.
Oh, and this is before 20 years’ worth of taxes and fees.
The same no-growth scenarios happened between 1936 and 1947, and again from the end of 1999 to the end of 2008.
Losses in a single year, whether in 2022 or 1974, are recoverable. But how do retirement plans, college dreams and other life goals recover from 5, 10 or even 20 years of no returns? Who can afford a lost decade or two?
Wall Street is currently scratching its collective brow and pretending to be puzzled by what happened last year. To no one’s surprise, their preferred solutions all involve us giving them more of our money to invest in higher-fee investment products known as “alternative assets,” including private equity, real estate and credit funds, hedge funds and so on.
But there’s a simpler answer.
The problem with 60/40 last year wasn’t so much the stocks — but the bonds. We expect stocks to tank sometimes. It’s why we expect them to pay us the big bucks long-term. But we don’t expect bonds to fall 18% in a year. So much for stability.
That’s been the big problem in previous lost decades. Bonds barely kept up with inflation in the 1960s, and they lost money in real terms in the 1940s and 1970s. Rising inflation leads to rising interest rates, and someone holding long-term bonds ends up a two-time loser. Their coupon payments are worth less and less in real terms. And they can’t take full advantage of new, higher interest rates because they are locked into old, lower rates.
They’d have been better off with cash — including, in investment terms, Treasury bills, savings accounts and money-market funds. Wall Street hates “cash” though, claiming that, despite its stability and liquidity, it offers terrible long-term returns. Clients are always being urged to swap their money from cash to products that actually generate fees — or as they say, “returns.” Investors are often told to “put that money to work.” But last year it went “to work” and took home a negative salary of 23%, as bonds, as well as stocks, did far worse last year than Treasury bills.
This is not a one-off. Actually, a modern Rip Van Winkle would have been better off leaving his money in Treasury bills than 10-year Treasury bonds for an astonishing 33 years last century, from 1949 to 1982. The difference wasn’t slight, either. Short-term bills generated twice the total returns over that period to bonds.
Warren Buffett has given instructions that after he dies his fortune should be invested mostly in stocks but with 10% in Treasury bills — not bonds. British financial consultant Andrew Smithers reached a similar recommendation when he did a very long-term analysis for his former Cambridge University college (which was founded in 1326, so we really are talking long-term). Cash, not bonds, offered a more reliable counterweight to stocks, Smithers found. His preferred alternative to 60/40 was 80/20: 80% stocks, 20% bills.
Meanwhile, Wall Street can stop pretending it doesn’t understand why 60/40 failed last year. It knows full well. Treasury bonds were almost guaranteed to fail sooner or later because they already locked in negative real, inflation-adjusted yields. At the start of 2022, a 10-year Treasury bond had a yield, or interest rate, of 1.5%. Not only was the Federal Reserve’s official long-term target 2%, but the actual inflation rate at the time was 7%, and the bond markets were expecting it to average 2.6% over the next decade. Inflation-protected Treasury bonds took the madness further: They locked in negative real interest rates. They were guaranteed to lose purchasing power over time.
Long-suffering bondholders in the 1960s and 1970s developed a laconic term to describe their dismal investments: “certificates of confiscation.” They didn’t make you money, they lost you money.
Maybe Treasury bills are a better counterweight to stocks over time than bonds. Maybe not. But it would stand to reason that bills — or gold, for that matter — might be better than bonds if the latter is actually guaranteed to cost you money.
“I’m no genius,” wrote a friend who recently started managing money, “but I’m writing to a client now that not owning anything [i.e., any bonds] but short and ultrashort bonds was the smartest thing I did last year. Never will avoiding something be so obvious again.”
While the 60/40 portfolios were down nearly 20%, his clients were down just 6% to 8%.