The Balanced Growth Model ‘Beats’ Through The Last Market Cycle

What is the Balanced Growth Model? Typically, it would be in that asset allocation ballpark of 70% to 80% stocks with the remainder of the portfolio in bonds. Certainly you can stretch that to 90% or so and still call that a Balanced Growth Model.

With better risk-adjusted returns (compared to all-equity) and at times even better total returns, I often suggest that that Balanced Growth Model is investing in that sweet spot.

Of course that 90/10 split is what Warren Buffett recommends for his heirs. His heirs will inherit portfolios that are 90% S&P 500 low-cost fund and 10% Treasuries. Warren’s a smart guy, ha, he’s quite close to my suggestion of The Perfect Portfolio at 80% stocks to 20% bonds (Long-Term Treasuries of course).

From Mr. Buffett’s 2014 annual letter to investors:

My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors β€” whether pension funds, institutions or individuals β€” who employ high-fee managers.

The Balanced Growth Model from 2007

Here’s the 70/30 model from 2007 to end of September 2019.

Portfolio 1 is 70% iShares S&P 500 (IVV) and 30% Longer-Term Treasuries (TLT). The chart is courtesy of portfoliovisualizer.com

The magic of the Balanced Growth Model when it’s firing on all cylinders is that the value or gains from stock market bull runs are stored in the “safer” environs of the bonds or bond funds by way of that rebalancing process. You won’t have to watch 40-50% of your paper stock market gains vanish in a major market correction. Along the route, and depending on your target level for bonds, a certain percentage of your stock market gains are sold and moved to the bond bucket.

I demonstrate that event in this article Is it time to rebalance your portfolio?

And then the tables are turned as I suggested in that rebalancing post:

Your bond monies can then go value hunting

What? And you thought your passive approach was not all that active. Your passive investment approach is going to go hunting?

Yup. Of course the β€˜best’ time to buy stocks can be when no one wants them. As Warren Buffett reminds us we should be greedy when others are fearful. In the last recession bonds held up and then provided a modest β€˜spike’. That rebalancing mechanism would have allowed an investor to buy the stocks (with bond proceeds) when the stocks went on sale. That is part of the magic of rebalancing.

And again, that is why a Balanced Growth Model can outperform an all-equity approach. There’s a certain amount of Warren Buffett programmed into that non-emotional but automatic rebalancing process.

And certainly using Longer-Term Treasuries is not every investor’s cup of tea. Broad-based bond ETFs are often recommended for balanced portfolios. Here’s what happens when we substitute in iShares Core Bond Fund (AGG) in place of TLT.

The Balanced Growth Model 'Beats' Through The Last Market Cycle

While it’s a virtual tie to the beginning of 2016, the all-equity model certainly starts to pull away into 2017 and 2018. The iShares Core Bond Fund provides less inverse relationship to stocks. There is less value hunting. And yes TLT has simply outperformed AGG for the period to contribute to the TLT Balanced Growth Portfolio outperforming the AGG version.

Go shorter with your Treasuries

Many readers are uncomfortable with the longer-dated Treasuries that carry the greater price risk in a rising rate environment. And ironically it is that greater ability to move in price that has made it a better risk manager. You have to trust that potential for that inverse relationship. And as always past performance is no guarantee of future performance or inverse relationship.

Given that, investors may look to the iShares 7-10 year Treasuries offered by way of the ticker IEF.

That can help the cause slightly as IEF provides a little more counter-balance compared to AGG. Here’s the scenario with IEF as the bond component.

The Balanced Growth Model 'Beats' Through The Last Market Cycle

It becomes a virtual tie in late 2018 when we had the Grinch that stole Christmas correction.

To get to a scenario where a Balanced Growth Model outperforms (for most of the period), we would have to be more aggressive and take the stock component up to 80% as per the “Perfect Portfolio” article.

As always you’d have to ensure that you have the risk tolerance level to match. We see that the portfolio option did drop by over 40% in the last recession.

The Balanced Growth Model 'Beats' Through The Last Market Cycle

With some renewed volatility, the model is outperforming from 2018.

If we go back to the original TLT “suggestion,” we see some outperformance vs. the S&P 500 from January 2018 to end of September 2019.

Portfolio 1 is 70% IVV and 30% TLT.

The Balanced Growth Model 'Beats' Through The Last Market Cycle

As Ben Carlson points out on his wonderful blog awealthofcommonsense, US bonds have been doing their thing and then some. Even though stocks continue to perform well, there is the fear of what might come and that includes active managers reading the tea leaves on softer corporate earnings and fallout over President Trump’s endless trade wars.

Sometimes the bond markets like to get out ahead. And I will often write that the bonds are the adult in the room.

We don’t have to guess

All said, as sensible investors we don’t have to guess as to what will happen in the short term. If you hold a Balanced Portfolio and embrace that rebalancing mechanism, your bond portfolio will go shopping for stocks when the markets dictate – when the time is right.

We can ignore most everyone and everything.

Author’s note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. Rebalancing can certainly create unwanted tax events when investing in taxable accounts. This article is not a recommendation. As per the Seeking Alpha mantra, Read. Decide. Invest. If you liked this article, please hit that “Like” button. Hit “Follow” to receive notices of future articles.

Happy investing,

Dale

Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, BLK, WMT, TXN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.