History Shows Your “Balanced Portfolio” Is a Ticking Time Bomb

Forget conventional wisdom. Forget the popular notion that holding the right amount of stocks and bonds will keep you diversified and safe from market shocks. Forget what most so-called “market experts” are telling you--their money is not at risk.

History has proven that just about all it is dead wrong.

The Balanced Portfolio: Panacea or Myth?

Yesterday’s stock market crash was a reminder that stocks can fall as far as they had risen. In response, financial experts have been repeating the same advice: make sure your portfolio is well-balanced and diversified.

Not only is the principle of a balanced portfolio allocation a generally accepted piece of conventional wisdom, but it’s also still being taught in most finance courses across America. The problem is that historically, it never really worked. 

The principle of holding a balanced portfolio of stocks and bonds during a major downturn has proven injurious to many generations of American investors in the past century

And despite the harm that this principle has done to investors, financial experts and advisors would rather continue giving bad advice than admitting what they don’t know. Why? Because they get paid to “know” and to give advice. They are not necessarily paid to “do.” 

Remember, your financial advisor is not accountable for your loss. Losing you as a client, your advisor can recover that loss by seeking other clients. You, however, can’t just recover your loss as easily. Your advisor gets paid regardless, whether you make money or lose money.

In other words, when it comes to your money, your financial advisor has absolutely no “skin in the game.”

How Inflation Can Erode a 60/40 Stock and Bond Mix

Have you heard of a portfolio moving backward due solely to inflation? It’s happened. Take the period between 1938 and 1948. A 60/40 mix of stocks and bonds lost purchasing power due to inflation.

The same thing happened again starting in 1968. In this case, your purchasing power wouldn’t have broken even until 1984. That’s quite a long, long time.

Put it this way: if you gain 5% in your portfolio, and if inflation increases by 5%, you earned a “real” return of  0%, as inflation just took away your purchasing power. In other words, as the price of your investments rises in value, your portfolio actually goes down in value.

Inflation on the Rise Again? Not According to CPI

Inflation’s rise as measured by the CPI is not a worrisome factor, but that’s because the calculation had been changed, twice in fact.

Based on 1990 calculations, inflation would not be at 2.3% to 2.9% but above 6%. Based on the 1980 calculation, inflation would be slightly above 10%.

But why rely solely on a theoretical calculation? How does this “theory” match your experience? How’s your pocketbook doing when you shop for groceries? Are things getting more and more expensive...perhaps more inflated?

The fact is that not even the Fed knew what the end result would have been when embarking on the great economic experiment called Quantitative Easing. Now, the Fed doesn’t really know what the result will be as it implements the opposite policy, Quantitative Tightening.

What Are Regular Investors and Those Approaching Retirement to Do?

So where does this leave the average investor? Sure, active traders may seek an opportunity to “go short” the market. But what about most ordinary savers, particularly those saving for retirement? Is there a better alternative than the traditional 60/40 stock to bond allocation?

Perhaps we can learn something from the past. The 1970’s, for those who were there to remember, was a period of high inflation. Many investors invested in gold and other commodities to mitigate the risk of rising prices. This was also a time when gold rose from $35 an ounce to $1,000.

Might such a strategy work today? Here is where you have to ask yourself, “am I looking to hedge against price or purchasing power?”.

Clearly, stocks, bonds, or cash can’t protect against the erosion of purchasing power as they are all denominated in US dollars. It appears that gold is the only form of money that can actually serve as a legitimate hedge.

How to Build an All-Weather, “Permanent Portfolio”

Harry Browne, the late investment guru, came up with this notion of the “Permanent Portfolio.” This all-weather portfolio consists equally of four asset classes: stocks, bonds, cash, and gold bullion.

Rebalancing would consist of ensuring that asset allocation remains equally divided into these four groups.  Unlike the traditional 60/40, this allocation would have helped through the market and inflationary turmoil of the 1940s through the 1970s.

No matter how much gold may have fallen out of favor in the last few years, the fact remains that its price still moves independently of equity and debt assets. Not only is gold a strong diversifier, but it also happens to be the best insurance against inflation.

If you are concerned about the upcoming downward market cycle and would like to maintain robustness through declining price values and rising inflation, you might want to consider this conservative allocation, keeping a fourth of your portfolio in gold bullion, stocks, bonds, and cash.

If you don’t have a physical precious metals account, GSI Exchange can assist you in setting up a self-directed IRA account to purchase gold in a tax-advantaged environment. We can also help you select between gold coin and bullion (and silver) products to better match your investment goals.