As we all know, the stock market has plunged this year, with the S&P 500 down 21%.
Bonds should act as a hedge against stocks. But fixed-income markets also struggled, with the Bloomberg Composite U.S. Bond Index down 11%. So what should investors do?
According to The Wall Street Journal, many are flocking to liquid alternative funds — mutual funds and exchange-traded funds, whose investments are similar to hedge funds.
Those funds have flowed in $21 billion so far this year as of May, according to a Morningstar Direct report cited by The Wall Street Journal. At this rate, inflows for all of 2022 will surpass last year’s record of $38.3 billion.
Returns are everywhere: The Wall Street Journal cites one fund that has returned 38% so far this year, while others have returned negative 10%. The average gain so far this year is 17%, according to Morningstar.
In addition to the volatile returns, the fund also has high fees, as high as 3%, according to the Wall Street Journal.
60-40: Dead or alive?
The traditional rule of thumb requires investors to weight their portfolio 60% in stocks and 40% in bonds. The model is “dead,” Shana Sissel, founder of Banríon Capital Management, told The Wall Street Journal.
But Roger Aliaga-Diaz, chief economist for the Americas at Vanguard Group, disagrees.
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“Brief simultaneous declines in stocks and bonds are not uncommon,” he wrote in comments. “Since the beginning of 1976, the monthly nominal total returns for U.S. stocks and investment-grade bonds looking at nearly 15% have been negative.”
But that’s only part of the story. “The longer the time frame, the less frequent the joint declines,” Aliaga-Diaz said. “In the past 46 years, investors have never had a three-year loss in either asset class.”
Still, 60-40 portfolio declines are more frequent than both stocks and bonds. “That’s because stocks are much more volatile and they are more heavily weighted in that portfolio,” he said.
“Over the past 46 years, the one-month total return has been a negative one-third. The one-year return for this type of portfolio is about 14%, averaging every seven years.”
But the outlook remains bright for Aliaga-Diaz, a 60-40 portfolio. “The 60-40 portfolio is targeting long-term annualized returns of about 7%,” he said. “That means achieving it on average over time, not every year.”
From 1926 to 2021, the 60-40 portfolio has an annualized return of 8.8%. Looking ahead, Vanguard forecasts an average long-term return of around 7%.
Of course, that doesn’t mean it’s always been smooth sailing, Aliaga-Diaz said.
“Market volatility means that diversified portfolio returns will always remain uneven, including periods of higher or lower — yes, even negative — returns.”
Additionally, the math of average returns suggests that strong performance in a 60-40 portfolio should be followed by weak performance and vice versa.