Investment portfolios aren’t just put together from bits and pieces of income-producing assets. Depending on an investor’s goals or objectives, these portfolios are based on asset allocations. Asset allocation describes the process an investor uses to divide capital among different asset classes such as stocks, bonds, and alternative assets. Asset allocation can be useful in diversifying risk and exposure to various investments.
There are many types of asset allocations. The 60/40 allocation tends to be used the most, with 60% of a portfolio directed to stock holdings and 40% of the portfolio containing bonds. Then there is the 75/25 asset allocation. This strategy means the investor puts 75% of their capital into stocks and 25% into bonds.
More in Retirement?
During the 1980s, investor Peter L. Bernstein suggested a 75/25 split between equities and bonds, versus the 60/40 allocation model. His reasoning? While equities can return less than bonds, they tend to outperform when bonds lose money. Additionally, equities would keep pace with bonds about a third of the time, he said.
Moving to 2020, Jeremy Siegel eschewed the traditional 60/40 allocation model. Siegel, who is a professor of finance at The University of Pennsylvania’s Wharton School, as well as a senior investment strategy advisor at WisdomTree, stated that a 60/40 allocation wouldn’t provide enough income in retirement, given the (at the time) low interest rates on bonds and (again, at the time) higher returns on stocks.
Using a higher equity percentage and lower fixed-interest model would “be the best way for those approaching retirement to establish their assets to get enough income and gains,” so they would have enough to finance their retirement, he told CNBC.
According to Siegel, the Siegel-WisdomTree Longevity Model, which supports the 75/25 allocation, can be useful for investors who want to balance income with longevity risk. Investors following this model are likely comfortable with a little extra investment risk for the potential of more income in retirement.
Then and Now
Siegel’s thoughts about the 75/25 asset allocation were announced during a time of low interest rates and high stock valuation and returns. Fast-forwarding a couple of years, things have changed. Interest rates continue increasing, while the value of equities has declined. Furthermore, volatility seems to be the main path of today’s investments.
How well does the 75/25 strategy work in today’s specific environment? Ben Carlson with Ritholtz Wealth Management reported that between 1950-1981, returns from a 75/25 asset allocation were 9.7% compared to the 8.1% returns from a 60/40 asset allocation. But volatility and risk were higher with the 75/25 allocation, clocking in at 13.5% (versus the 10.8% from a 60/40 allocation).
Yet the 75/25 asset allocation portfolio outperformed because, as Carlson put it (in the words of Peter Bernstein), “cash outperformed bonds.” It’s also important to remember that the period included the 1970s, which consisted of high rates of inflation and stagflation.
Is the 75/25 Allocation a Good Strategy?
Before any investor jumps into rebalancing their portfolio to reflect a 75/25 asset allocation strategy, Carlson acknowledged that the “75/25 portfolio is not a perfect solution. But the perfect solution doesn’t exist right now.” Investors looking for higher returns in the current high-interest, low-return environment will have to live with higher volatility and more risk.
As such, the 75/25 asset allocation method isn’t necessarily a good or bad strategy. It’s based on an investor’s appetite for risk and what returns they’re looking for. For any kind of portfolio rebalancing or strategy shift, it’s always a good idea for that investor to consult with a financial planner.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Neither asset allocation nor diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage risk.
Rebalancing can entail transaction costs and tax consequences that should be considered when determining a rebalancing strategy.
