We have all heard the phrase “past performance is no guarantee of future results.” The average 60/40 stock portfolio has performed quite well since 1982, with an average return of about 10.2 percent1, although the average equity mutual fund investor typically earned less than 4 percent2 during that time, but that’s another story.
The last 36 years had optimal conditions for a 60/40 portfolio. In 1982, the bond portion of one’s portfolio was enjoying historically high interest rates as the five-year treasury was yielding 14 percent1, whereas today the five-year treasury is yielding about 2.85 percent3. So, in this case, past performance is completely unrelated to future results because interest rates are now so much lower and therefore the bond portion of one’s portfolio is likely to substantially under-perform historical returns.
Back in 1982, stocks were much cheaper than they are today. When investors were able to earn 14 percent, risk-free stocks were relatively unattractive: They were only willing to pay about eight1 times the annual earnings of stocks at that time. However, as interest rates fell to historic lows, stocks became relatively more attractive because the alternative of investing in low-risk treasuries had become so unrewarding.
Today, investors are paying about 32 times earnings for the S&P 500 index4. In other words, the less reward investors can get in low-risk bonds, the more likely they are to increase their appetite for risk in order to enhance returns.
This is part of the reason stocks did so well. The growth in stocks was not fully attributable to the growth in earnings. Rather, it was attributable to a growth in what investors were willing to pay for those earnings. As interest rates rise and investors are once again able to obtain higher risk-free returns, stocks may under-perform if earnings multiples contract to historical averages.
1Advisor perspectives, 2Dalbar study, 3CNBC, 4Ycharts
Ready to Take The Next Step?
For more information about any of the products and services listed here, schedule a meeting today or register to attend a seminar.