The 60/40 Guys

Bob Stowe |

On a recent Saturday morning I was listening to the money talky guys on the radio. This particular one, an indexed annuity salesman, referred to fee-only advisors as ‘those 60/40 guys.’  I laughed out loud because it was funny and every good joke has its kernel of truth.

The 60/40 idea started in pension portfolio management. The idea was to meet obligations over an unknown length of time, potentially decades, and failure was not an option. A 60/40 portfolio does not necessarily give the best risk-adjusted return and definitely does not give the best return when compared to higher, stock concentrated portfolios. Using Monte Carlo analysis, the 60/40 portfolio’s claim to fame is to provide the best return of a survivable portfolio. This is in the wheelhouse for a fiduciary, which means fee-only, which is also ‘those 60/40 guys.’ The indexed annuity guy just differentiated himself from fiduciaries at a time when prospective clients ask that question first. Attaboy.

When beginning a relationship with a client of unproven risk sensitivity, 60/40 is a good starting point. The two separate demands, growth to meet future needs and the imperative to not scare off a new client make 60/40 a good portfolio, at least initially.  As the relationship develops it is common to arrive at a better understanding of risk and move away from 60/40. More or less risk may get us where we need to go with less perplexity. This understanding doesn’t come easy. Generally, the first big (more than 20%) correction in the stock market is needed to really understand how we tolerate risk.

Even defining risk is not easy. To a planner, risk is the potential to not meet your goals. Higher returns help towards that end, but brings with it more volatility.  To the client, risk generally means loss, even of a very short duration. Avoiding loss means avoiding volatility, which comes at the cost of lower returns.  In the media, risk is usually expressed as volatility. I think you can see the problem.  We can’t even agree on terms.

In modern planning, statistical tools have evolved to give us a better understanding and a common language for risk, as well as strategies to manage it. In the next post we will look at defining risk as it pertains to comprehensive financial planning and investing.