Set and Forget

Matt: 00:02

Wait, so we're not calling this 10 ways Kim Kardashian's cleavage will save your financial portfolio? That’s not what we’re doing?

Mike: 00:07

No, that is what we're doing. No, that's what we're calling it. It's called like a tease so that people click on it, Matt, but then we'll just give them something totally different.

Matt: 00:16

That's called clickbait. Hey, it's financial planning. I'm Matt Robison, with my co host, Mike Morton. Who is the actual resident expert here. And we are just debating, could we make today's episode title a little bit sexier? Probably not. You wanted to call it the 60,40 401k portfolio is dead?

Mike: 00:35

Well when you read it in that voice? Of course it’s terrible. That's just your reading job.

Matt: 00:39

Oh, give me, all right. Give me the hot version of that, please.

Mike: 00:43

What it's dead, a 60,40 401k portfolio is dead?

Matt: 00:47

Nope, that didn't work. What is the 60-40 401k? Portfolio?

Mike 0:52

That's a good question. All right, yeah so the 60-40 portfolio Matt, is 60% stocks, 40% bonds. When you talk about asset allocation portfolios, you often have these two halves that you start with stocks and bonds, and reminder that stocks are, you own a piece of the company. So as the company does better and makes more profits, you actually own a piece of that, and they'll give you some dividends or that goes up in value, because it's worth more because the company is growing, making great profits, and you own part of that company. Whereas bonds are an IOU, you've lent money to somebody, and they usually pay you some interest. And then you get your money back, assuming that company or whoever you lent it to does not default does not renege on their promise to give you the money back. Ownership stocks. IOUs bonds. 60-40 is this classic portfolio that’s studied throughout history 60% stocks, 40% bonds, rebalancing back to that 60% 40% every year, and it's been a tremendously great portfolio over the last 40 years it’s just done really well. So it's been highlighted many times it's been a great portfolio to have 60-40. And that's where you see these titles. And that's what it means.

Matt: 02:06

Got it. So this is basically the eulogy that we're doing here for the 60-40 401k portfolio. We talk a lot about diversifying your portfolio, you explain a lot about why you want a proportion in stocks or proportion in bonds. Sounds real basic. But why do you want to split your financial assets between stocks and bonds in the first place?

Mike: 02:30

Oh, man, I love that question. So you don't have to, you can be 100% stocks. And if I was recommending someone who's 24 years old, just getting their first job just setting up their first 401k I would say go 100% into stocks, not 60-40. All right. But the reason we tend to have this diversification in stocks and bonds is they behave very differently. So stocks tend to go up more, they tend to give more return over time, alright, so they tend to do better, you’re going to make more money owning stocks. That's why I get that 24 year old advice, hey, just own 100% stocks, you will make more money over time. The problem with stocks is that they're riskier, we use the word risk, they're riskier what that means in this context is they’re volatile. Alright, so don't confuse the two between risk and volatility. They're more volatile, which means they go up and down more often throughout the month, the year, and things like that. So your 100% stock investment could lose 30% or 40% or 50% of its value in a single year. And that really that hurts losing 40% even cut in half maybe 50% of your value in one year. Whereas bonds are the opposite. They don't make a whole lot over time. They do pretty well, they chug along but they're not nearly as volatile, they don't go up or down nearly as much as 5 or 10% would be a massive change in a year for bonds. And we did have that recently. But that's a real outlier when it comes to these IOUs, lending money especially and then there's a each of those stocks have a whole range of risk and reward, I could lend money to Matt’s startup company. And I'm pretty sure that's going to be super volatile, they're going to hit it massive 100x return or it's going to go to nothing, I'm going to lose all my money, versus the S&P 500 or the US stock market is not going to be nearly as volatile. The same with bonds. If I lend money to the US government, I'm pretty sure I'm getting my money back like they're a pretty good return of the capital that you lend to them. So you can buy US Treasuries US bonds, but if I lend it to emerging markets or to any again, single companies would issue bonds, I could lend it to Matt might want to borrow someone I could lend it to him. That might be a riskier lending. So each of these have a lot of range in terms of their volatility and their risk of lending.

Matt: 04:50

Lending me money is a great idea to do it, as long as you have no expectation of payback.

Mike: 04:57

Why?

Matt: 04:58

What I guess, what I don't understand is you're explaining, you're going to make more money if you're in it for the long run, if you're in stocks, and when you're talking about here in our sexy title, the 60-40 401 K portfolio is dead, 401 K is for your retirement. That sounds like a long haul proposition. So why was this ever a thing? Why was a 60-40 split with 40% in bonds, if you're in this for the long haul for your retirement?

Mike: 05:33

So this comes from the Wall Street Journal article, and a friend of mine passes over to me and said, hey, Mike, I would love to talk about this. I'd love to learn more. So here we are, Matt. That's why we're talking about it. So this was a Wall Street Journal article that was called your set and forget 401k made you rich, no more. So that's the title of the article. So I thought we'd discuss some of the things that it said inside of there. And it really started off with a 60-40 portfolio. That's why I pulled it out, which I don't know why they did that. Because like you just said, Matt, if you're in your 20s, and 30s, the target date funds, we've talked about target date funds in your 20s and 30s. Those target date funds are like 90% stock. Okay, so they're gonna be a much higher percentage of stock. So it's not really a 60-40. But that's what they pulled out in this article. And the reason I'll pause there, and then we can get into why?

Matt: 06:23

No I’m genuinely mystified please go on? No, this really makes no sense. That's why the settings on your mimeograph machine may no longer be up to date. It's yeah, have you heard of target date funds, we have modern things that like, it doesn't make sense to me.

Mike: 06:38

They're conflating two different things here. So they mentioned the 60-40 because it's been this classically researched portfolio, like I just mentioned. So I think that's why they threw it in there. And they threw in some statistics around how that portfolio has done over time. And it's done really well. And then trying to save in your 401k, you might really want to pay attention to this, because that's your retirement. So it's just trying to catch people's eye. But one of the points they brought up in there, which is what I want to talk about a little bit is the bond side, I said bonds are not, they don't go up and down nearly as much, they're pretty safe. But the reason the 60-40 has done really well and if you did have that in your retirement, because target date funds are relatively new. So maybe 40 years ago, you just had this split 60/40 and just set it and forget it. And it's done really well for you and part of that reason, is because the bond side has done really well over the last 40 years, the last 40 years for bonds has been tremendous, compared to say the last 100 years. Alright, so the last 40 years have been really great. Now a lot of that comes down to when your endpoints are. And so if you take the slice of time, the last 40 years from, say, the mid 70s, right, but if you go back to the mid 60s, say shifted by 10 years and take that 40 years, it's going to be a lot worse. So it really depends on the endpoints. But the last 40 years have been great for bonds for the following reason with what was going on in the 70s. Matt, where was inflation and interest rates?

Matt: 08:08

It's my favorite word in the world. Stagflation. It sounds like you're going out for a bachelor party and you all blow up balloons, I guess.

Mike: 08:19

Where’s the deer?

Matt: 08:22

Stagnancy with inflation. Boy, that's a portmanteau that really should be retired. But yeah, high inflation. And it's interesting because we had this little recession in 1981 to 1982, which was actually terrible is really a fun fact. Like for people of our age, you might remember the classic political ad Morning in America 1984 Ronald Reagan, right, things are so much better than they were turns out, not entirely true. In fact, inflation and unemployment were worse in 1984 than they were in 1980 when Mr. Reagan assumed the presidency, it's just that people have a certain amount of recency bias. And things got so horrible in 1982, including with inflation, that people were like, oh, yeah, things are better than they were two years ago. So that's essentially what happened. But since 1982, we've had 40 years of historically low inflation.

Mike: 09:23

But the starting point, again, you just mentioned it, high inflation, high interest rates, above 10%. All your borrowing was over 10%. All your investments in bonds were over 10%, you were making 15% I bet you could go out and just get 15% on your cash for 10-20 years, like 20 year treasury bonds. 15% I was like, Man, I would take that today. But the point here is this. So they're over 10% and for the last 40 years, interest rates have been falling. All right, from over 10% all the way down under zero and as we've had on previous episodes, when interest rates fall bond prices rise, now you don't get the interest anymore, you get less interest, but your principal has gone up in value. Okay? So the bond price when you're holding that bond rises, interest rates fall. So bonds over the last 40 years, the total return on bonds over the last 40 years is higher than it's ever been in a 40 year period from that falling from the high inflation, high interest rates falling all the way down. And that's why it's written up today. Right? Where are we today, Matt? Inflation spiking again, interest rates are starting to go up. We're only at 5-6%. But they're going up. And so that's really hurting the bond side of the 60/40 portfolio.

Matt: 10:45

That actually answers my question. I guess that makes a lot of sense then, right? So if you have a 40 year run of low inflation, great bond returns, then even a 60/40 portfolio in your 401K could make a lot of sense. Now look, I'm assuming here that if you're closer to retirement, 60/40 might actually still make some sense, but maybe not. I'm just saying that. Yeah, young in your career, if you've got a long time horizon, I see what you're saying about you want to be mostly stocks, if not all stocks, when you get a little closer, reducing that volatility, you don't want to have your whole portfolio wiped out because the stock market has a bad year,

Mike: 11:24

Right. Now, here's so let's talk about both of those. Because here's the other problem where we are today. So we've just seen the last few years interest rates rise and inflation rise. And so that's really crushed the bond part of our portfolio. And in 2022, both stocks and bonds got crushed, which was terrible. It's the first time it's happened in 50 years that both of them went down significantly. That's a problem. The other problem of where we are today, and again, the Wall Street Journal article highlighted this. And if you look up the Shiller P/E ratio, it gives you the sense of valuation of the stock market. And when I say valuation, it means how prices change, stuff like you have a sense when you go in the grocery stores, well, that isn’t normally the price of eggs. So the same is true in the stock market, how pricey is the stock market? And the Shiller P/E ratio kind of gets at that. And it's pricey. It's pricey. Okay, even though we've come down a little bit from the highs from 6-12 months ago, it's still very pricey. Now it's been crazy for the last 20 years, I'll be honest, okay, it's gone up and down. But it's been on the more pricey side. But the upshot is this, when the stock market is more priced in, we're just talking stocks here, not bonds, when the stock market is pricier, okay, of course, your future returns aren't going to be as good you're buying like a high you're buying at the expensive time to buy something, versus if there was a time that the stock markets a little more average or a little bit on sale even. That's when you'd love to buy in. So right now, the other problem with the next 10 years is that we're at a higher stock price. So you're buying that $100 and over the next 10 years, it might not get much above $100, maybe in a year return. So the return future returns aren't looking too good, based on where we are today. Are you ready to create your ideal lifestyle? Let's discover what's most important to you and design a plan to have more of that in your life. Go to meet Mike morton.com. All one word meet Mike morton.com.

Matt: 13:34

That makes sense to me. If the price of what you're getting as a ratio compared to the earnings that the underlying companies are getting, if it's relatively high, I mean, in general, you're saying like that’s maybe a little overpriced. This doesn't seem like as good an investment. So why is the 60/40 ratio so dead then if we're in a perhaps slightly overvalued stock market environment? Why don't bonds look more attractive at all just the inflation and interest rate?

Mike: 14:12

Bonds are still good. And they're always good to have as a balance again, depends on what kind of bonds that you have. Now let's talk before we can get back to the price of stocks and what to do about that. There's not, unfortunately not a ton you can do that's just where we are, the store has a dozen eggs. And if you want to buy eggs, that's what you have to pay. There's no market substitutes here. So there's a few things that you can that you could think about doing. But basically, yeah, no market substitutes. So you just put away your 401k payment for the month from your paycheck, it gets automatically invested, and that's what you're buying. So now on the bond side, we've taken a big hit. I said in the last couple of years bonds have gotten crushed, and because interest rates are going up from zero very quickly the fastest that the interest rates have ever risen, which really hurt total bond returns. So we're in I think we've taken a lot of the pain. But could it get worse from here? Absolutely. I told you we were 5 or 6%, could go to 12%. Yes, that could happen. So we'll see what comes next but let's turn to your other question around retirees. So what do you what do you do then? Stock prices are pretty high, maybe returns aren't gonna be that good for the next 10 years, you don't know where bonds are going to go from here. Are they going to continue to chug along? Are they going to get crushed again or not? If I need to live off this portfolio, what do I do? So here's the way to approach that, I do with all my clients, you want to set aside the money you're going to spend for the next 5 to 10 years in very safe assets. Specifically, I use short term bonds or even CDs, something that US bonds, a two year-three year, or just a super short term bond fund, you get 5% on your money right now. And it's really not at risk of going down, you can lock it in with six months CD 12 monthsCD, three year CDs, get that same kind of 5%. So that is money that you need. And three years from now, when you're on a fixed living expense, almost no longer working or you're in retirement not working. So you need to spend $50,000 to supplement your Social Security, take the fifty thousand and have it available for the next seven years. $50,000 a year, for each year over the next seven years. The rest of your portfolio could be in these slightly riskier stocks, maybe a little bit more bonds, but basically stocks, so seven years or 10 years of actual spending held in superset not just a bond, general bond portfolio, but super safe CDs, or US Treasuries. So that money is going to be available. If we have something where stocks and bonds get crushed. Again, we're in a recession, it goes for five years before it comes back. You've got your money safe and available to spend.

Matt: 16:54

That sounds like a pretty defensive strategy. But what you're saying is that we're in a position where there's a lot of uncertainty and you can't rule out anything and you want people to protect their position first, protect their core assets for the next five to seven years.

Mike: 17:09

Yeah, here's the thing, I'm a very big risk taker. All right. So I like going in on stuff and I'll take whatever comes my way, I'll take and roll with that. But most people aren't like that. And most people can't take and roll with whatever happened to ‘my portfolio is down 35%’. Cool, I'll just roll with that. Guys, like I had to replace my car, I've got my mortgage payments, I got stuff, I got stuff I got to spend. So that's where we lock in like the next 5 to 10 years in cash, it's safe and available. Because I'm telling you like I just told you the expense, the stock market's a little bit expensive. Don't expect stellar returns in the next few years. You never know what the next few years is going to be, but even the next 10 years, I'm not going to expect 10% a year for the next 10 years because of the the prices at the current levels. And so I would definitely lock in your actual spending for the next 5 to 10 years having that knowing exactly where it comes from. Because when you look at previous recessions, and the stock market, the dip on the average is three and a half years. So between Oh, it was a peak, and then it goes down and then comes back up three and a half years, but longer ones take up to 10 years to come back and recover. So any of your stock that you have investments in the stock market, think of 2000 to 2010, they call it the lost decade 2000-2010, the stock market was super expensive, then it got crushed. And then it slowly came back up and got crushed again. And so your 10 year return was not that great. Now there are periods in there, you could take some earnings, but your 10 year return wasn't that great. So you have to have some defense, if you're on retirement, you're no longer working, you got to think defense first.

Matt: 18:51

Let's talk about the offense side, though, a little bit. Because hopefully, once you've done this step of really trying to protect your next five to seven years, you still have some assets that you're looking at wanting to grow a little bit more aggressively than that. Now, you're not suggesting that people get super exotic or going for commodities or like Turkish prisons, you're still saying stay within the stock market for those growth opportunities.

Mike: 19:22

Yeah, and we've talked about it low cost index funds, good diversification, US International big companies, small companies. I will say this though, the Wall Street Journal article had the quote, the quote is, you might want to look in other places than just the US large cap. So small capitalization, emerging markets and value stocks offer the benefit of diversification and what seems like much cheaper prices. That's a quote from the journal article. And I agree that in general, I would have, let's say the stock side of your portfolio, so you're in retirement, you set up 10 years have save $500,000. So you've got $500,000 and very short term treasuries and CDs and stuff, the rest of the money that you're going to spend 10 years from now, I would say yeah, you could put that into the stock market. And so that side the 100% stock market, I'd have 80-70% of it in US large cap international large cap, a good bulk in those low cost index funds with the large cap stuff. But I definitely diversify into small cap stocks and emerging markets and the value stocks. I think I agree with the Wall Street Journal, that it's a good place for looking. They've been cheap for a while they haven't performed that well I'll be honest, I've been in them for a few years. And they haven't done well the last few years. But I still had the expectation that they are cheaper. They're way, way cheaper. Okay, so future returns 10 years, let's measure in time, 10 year time horizons should be a little bit better. So you can look at diversifying into those asset classes. Again, there are low cost index funds for emerging markets, and for value stocks, so you can look into those.

Matt: 21:03

Alright, this has been a very meaty and practical conversation. So I want to get a little bit more esoteric as we wind down toward the end. Look, when I studied economics in college longer ago than I'd like to admit, I was super into macroeconomics, public sector economics, my financial economics course, I have to say, just never really resonated with me, which is why I'm perfect for this show. Because I can ask a lot of dumb questions. Like, I'm not just I'm not just whistling Dixie here. I guess what I don't understand is, you were talking about price earnings ratios. And this measure of, okay, what we pay for stocks seems to be a little bit higher than the underlying value and earnings that the companies are producing. That should be what you're paying for is right. And are these companies going to make money or not? I guess what I don't understand is, as we're recording this, we're fresh off the news that the last quarter GDP growth in the United States is 4.9% That is robust, that is strong. And there's a lot of this underlying public sector investment. This is something I know more about, I'm more in my wheelhouse, where we've got investment in infrastructure, which is the productive capacity of the economy, overall, the relative efficiency of businesses, the logistics of businesses, we have this investment in semiconductor technology, manufacturing, advanced manufacturing and electric vehicles and other kinds of, you know, green technologies. It's a lot of really good pro growth with a short term data about growth of GDP. And sort of these longer term, hey, the government is making some investments here that we should expect will help our American businesses over time. Why is that P E ratio so far out of whack? Why is the stock market overvalued? Aren't there indications that earnings should continue to grow and be strong into the future?

Mike: 23:07

Earnings are usually continuing and strong and they usually go up over time. So that's good news.

Matt: 23:14

Yeah, that's my second question. I'll get to that. But the cape ratio

Mike: 23:18

So it's called the Shiller Cape ratio. And you've said a few times, it's the price to earnings. And it's a measure of how much you might overpay the price for the earnings of the company. Now, in a perfect world, Matt, we'd be able to measure all these things. And I can tell you exactly how much Google is worth. Because I know how much they're earning. I know their capitalization and everything. And so you can use a discount rate until you know exactly what Google is worth. And if I know what Google's worth, and I know what the whole markets worth. And I can tell you exactly what we should be paying for the S&P 500. The problem is a couple of things, you're making a lot of assumptions, all right in there, like the discount rate, which is tied to interest rates, which clearly, we don't know where they're going, or who would have had good predictions a few years ago. The other biggest problem is really that you're dealing with humans. And that's what it comes down to. That's why there's no way to know what's going to happen in six months, 12 months or two years, even though I have an inkling for 10 years to 20 years, I'm getting a little bit more confident with my predictions. The next couple of years, you have no idea because it's all comes down to humans, because the humans set the price. The humans are deciding what we're going to trade for Google stock, what it's worth, and depending on the news cycle. So in the pandemic, right, suddenly the news was all shutting down and this and that depends on the news cycle. People get very fearful and lots of selling Matt. The world is coming to an end, the death of stocks, right, the death of equities, the world is coming to an end. We have to get out of these things. The Black Swan, S&P 500 Losing 20% in a single day. It’s like did earnings of all these companies chang 20% overnight. No. So that's where the price really fluctuates is because the payments involved?

Matt: 25:08

There’s an old saying in economics which is half a joke half just a reality is when you ask what is something worth? It's like, whatever someone will pay for it. And that's definitely the case in the stock market. Look, my other esoteric question was going to be what you alluded to a second ago. Why do stock prices go up? But let's save that I seriously want to save that. Let's do that in a future episode, because it's not inherently obvious. Like, why do things always get better and more valuable? That doesn't necessarily compute.

Mike: 25:36

Rising ocean loads all boats? It's perfect.

Matt: 25:40

Why are the oceans rising? Oh, wait, the answer that is known and depressing. Was I talking about that? I'm not talking about the death of the 60/40 401k. Alright, anything else to cover? No,

Mike: 25:50

That's it. There was a lot in there.

Matt: 25:53

Great advice. As always, for Mike Morton we'll see you next time.

Mike: 25:57

Thanks, Matt. Thanks for joining us on financial planning for entrepreneurs. If you liked what you heard, please subscribe to and rate the podcast on Apple, iTunes, Google Play Spotify, or wherever you get your podcasts. You can connect with me at LinkedIn for more than financial advice.com I'd love to get your feedback. If you have a comment or question please email me at financial planning . Until next time, thanks for tuning in. This recording is for informational purposes only and should not be considered for investment advice or opinions expressed as our of the date of recording. Such opinions are subject to change. We do not guarantee the accuracy or completeness of the data presented here.