COVID-19 proved uncertainty reigns supreme. Fifteen months ago, nobody expected a pandemic would pour concrete into the global economy. And if a seer (like that creepy eyeless dude on the Netflix series, Vikings) did predict this, we would have laughed him out of his cave if he said stocks would soar. But that happened in 2020. Despite the pandemic, Vanguard’s U.S. stock market index (VTSAX) gained 20.99 percent. Global stocks, as measured by Vanguard’s Total World Stock Market Index (VTWAX) gained 16.69 percent. It seems COVID-19 fertilized stocks.
When it comes to stocks and bonds, nobody can see the future. I remember the general sentiment about portfolio allocation twenty years ago. It was reflected in one of the most popular investment books from the late 1990s, The Motley Fool’s Investment Guide. The authors recommended portfolios of 100 percent stocks. Here’s a big reason why: from 1980-2000, U.S. stocks gained 15.24 percent per year. That would have turned $10,000 into a whopping $196,730.
Meanwhile, syndicated columnist Scott Burns continued to write about the Couch Potato portfolio, which he introduced in 1991. It includes 50 percent in a U.S. stock index and 50 percent in a U.S. bond market index. Over the previous 20 years, stocks beat bonds by almost 9 percent per year. Many people thought that putting 50 percent in bonds, as Scott Burns suggested, made little sense.
However, stocks crashed in 2000. They fell again in 2001. And in 2002, they sank further. Suddenly, the Couch Potato portfolio didn’t look so silly. It didn’t drop as far when stocks fell, and it took the U.S. stock market index 19 years and 8 months to catch the potato.
Most people, however, don’t invest a one-time lump sum. Instead, they add money over time. Assume two people each had $1000 in January 2000. The first person added $100 a month to a U.S. stock index. The second person added $100 a month to the Couch Potato portfolio (50% stocks, 50% bonds).
In this case, the person who invested 100 percent in a U.S. stock index would have required thirteen and a half years to catch the Couch Potato investor.
But that person would have required nerves of steel. After all, the stock index suffered several massive drops. Would our hypothetical investor have stayed on course? Or would they have sold when stocks were low, only to re-enter the markets after stocks had risen?
Nobody knows whether the Couch Potato portfolio will beat the U.S. index over the next 5, 10 or 15-year period. I’m no creepy seer. But I know what I don’t know. That’s why, when an investor asks me, “What percentage should I have in stocks and bonds?” I don’t have a strong opinion.
Here’s why: Imagine if the seer from that Vikings show were real. He says, “U.S. stocks will average 8 percent annually over the next twenty years and the Couch Potato portfolio will average 5 percent per year.” If I had this information, you might think I would recommend a portfolio that heavily favored stocks. But if I did, I might hurt the investors’ 20-year returns.
After all, even if I knew how an allocation would perform in the future (which is unknowable, by the way) I couldn’t predict how a person would perform with that allocation. Along the way, stocks might crash more than once. And I wouldn’t know how the investor would respond. For example, I don’t know how you would respond to getting cancer, losing your sight, losing the use of your limbs or losing a loved one. You wouldn’t know either, unless it happened to you.
That same rule applies to new investors. Until they’ve experienced big, consecutive calendar year drops, they won’t know how they would react. Individual resilience and emotional triggers differ.
That’s why I respect Scott Burns’ Couch Potato portfolio. It doesn’t matter how much or how little bond index funds earn. The far more relevant fact is that bonds don’t fall as far when stocks crash (sometimes, they even rise). This can calm investors when stocks sink. It can prevent investors from freaking out and selling low. It can encourage investors to rebalance and keep adding money. That’s why, an investor in a portfolio of 50 percent stocks and 50 percent bonds might beat plenty of investors with riskier allocations…even if stocks thrash bonds.
So, if a new investor asks you, “How much should I have in stocks and bonds?” please be careful how you answer. It’s tough enough to know how we, ourselves, would respond to adversity. That difficulty compounds when we’re trying to guess about someone else.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas