How much does each stock and bond allocation actually contribute to the total return of a portfolio? The easy assumption is that stocks do most of the work, since stocks outperform bonds historically.
To find out, I used the S&P 500 returns for stocks, 10 year Treasury returns for bonds, and rebalanced annually.
I threw all the data into a spreadsheet to get results for every allocation. To keep things simple, I’m only showing the 60/40 portfolio since that’s the typical allocation cited in most examples.
| What Drove Most of 60/40 Returns from 1928 to 2014? | ||
| Annual Return | % from Stocks | % from Bonds |
| 8.46% | 70.69% | 29.31% |
Stated simply – stocks did 70% of the work. No surprise that stocks drove most of the growth.
So rather than waste time explaining the obvious, I thought I’d look at how each decade broke down to see where stocks and bonds fell based on the average.
| Driver of Returns in 60/40 Allocation by Decade | |||||||||
| Decade | Annual Return | Total Return | % from Stocks | % from Bonds | |||||
| 1930s | 2.82% | 32.02% | 53.52% | 46.48% | |||||
| 1940s | 6.75% | 92.16% | 85.38% | 14.62% | |||||
| 1950s | 12.31% | 219.40% | 97.09% | 2.91% | |||||
| 1960s | 5.90% | 77.37% | 85.80% | 14.2% | |||||
| 1970s | 6.06% | 80.18% | 67.14% | 32.86% | |||||
| 1980s | 15.54% | 323.82% | 69.06% | 30.94% | |||||
| 1990s | 14.04% | 271.88% | 83.39% | 16.61% | |||||
| 2000s | 2.96% | 33.82% | 10.66% | 89.34% | |||||
Most of the time, stocks lived up to or exceeded the average. The two worst decades for stocks were the 1930s and 2000s. The 1930s started the decade with three consecutive losing years. The 2000s were the worst thanks to losses from 2000 to 2002 and 2008.
Both allocations performed about average in the 1970s and 1980s, but with very different total returns. The ’70s were hit with hyperinflation. The only year bonds played an exceptional role was the 1980s, but both stocks and bonds responded to the hyperinflated ’70s hangover with bull markets.
What breakdown shows is that when stocks fail to live up to expectations, bonds don’t pick up the slack in any meaningful way. In the two decades where stocks were responsible for less of the returns, it wasn’t because bonds did great. Stocks just performed terribly. The only decade where bonds performed great stocks did too, thus the highest total return in the ’80s.
Basically, you won’t get double digit returns from stocks without a few bad years. And bonds aren’t built to produce double digit returns without higher risks attached like hyperinflation. When either asset strings together a period of great returns eventually a period of poor returns follow.
Here’s two quick observations:
- Hindsight being what it is, it’s easy to say annual rebalancing hindered returns
- The results explain the temptation to write off stocks after the 2000s
Annual rebalancing certainly impacted returns in several decades. I used annual rebalancing only because it makes the math easy. I think it’s safe to say that allowing your portfolio to grow a little bit off kilter is okay. In other words, it’s okay to let your winners run…to a point.
The question then becomes how much? Making an educated guess – only rebalance after a 5% to 10% shift in an allocation. Ultimately, the time to rebalance depends on how comfortable you are taking more risk the further you stray (meaning letting one asset, primarily stocks, become a bigger piece of the pie) from your starting allocation.
The real risk you face is letting your portfolio run only because stocks are going up and you don’t want to miss out on further gains. At that point, it’s easy to forget the 20% of the time stocks fall. Or do the opposite, because stocks performed terribly you let your bond allocation run.
The temptation to write off stocks after the 2000s is understandable. The results were horrible, which is why people ignore history for the recent past. It’s all short term thinking.
What’s more likely to happen? Bonds repeat the bond bull market starting in the ’80s? Bonds follow the lower rates of the ’50s? Or bonds move closer to the bond bear market of the ’60s and ’70s driven by rising inflation? On the other hand, history shows stocks have a good record over the long term.
The lesson we can take from the 2000s is that just because something hasn’t happened yet, doesn’t mean it won’t. But it also doesn’t mean that just because something happened recently, it will happen all the time or again soon. While anything is possible, it’s not always probable. History is against it. Anyways, you diversify to protect from the rare chance the improbable happens.
