It’s one of the most time-honored investment beliefs—that individual investors should have a 60% equities-40% bond asset allocation. But Bank of America thinks that’s outmoded.
What’s the ideal new mix? More stocks and fewer bonds, according to a report by Jared Woodard and Derek Harris, BofA Merrill Lynch Global Research portfolio strategists. While they don’t specify a precise ratio, they argue that stocks have a better chance of generating the best returns in the future.
Their advice comes as bonds have shown a rally amid lower interest rates, which the Federal Reserve is fostering. Investment dollars are sluicing into bond mutual funds and out of equity ones.
Woodard and Harris contended that’s not a trend that will endure, adding that investors should be aware of the changing dynamic. “The future of asset allocation may look radically different from the recent past,” the pair wrote, “and it is time to start planning for what comes after the end of 60/40.”
They said that bond market volatility has made risk-adjusted fixed-income returns worse than that of any other asset class. except for always-fluctuating commodities. But the very popularity of fixed income is creating a “bubble” that threatens to pop to the dismay of investors who thought bonds were safer, Woodard and Harris predicted.
“The core premise of every 60/40 portfolio is that bonds can hedge against risks to growth, and equities can hedge against inflation; their returns are negatively correlated,” the duo said. “But this assumption was only true over the past two decades and was mostly false over the prior 65 years.”
This negative correlation has dwindled recently, they said, noting that stocks and bonds now have tended to sell off together. The BofA strategists emphasized that 1,100 stocks world-wide have better yields than do bonds. They suggested that investors favor high-yielding stocks in less favored (hence cheaper) sectors such as industrials and financials.
People need to wise up and realize “there are good reasons to reconsider the role of bonds in your portfolio,” they said.