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Vanguard suggests a 70/30 bond-to-stock allocation for better long-term returns.
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Stock valuations are high, making bonds more attractive despite elevated bond yields.
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Vanguard predicts US equities to return 3.3%-5.3% annually versusus 4%-5% for bonds over 10 years.
Stocks have surged since their mid-April lows, and valuations are being stretched — which is exactly why Vanguard says long-term investors should park more money in bonds than the conventional wisdom suggests.
The 60/40 portfolio, where investors invest 60% of their money in stocks and 40% in bonds, is a widely accepted approach to asset allocation. Some argue that an 80/20 split might even be more effective at driving returns for younger investors.
But investors might be better off taking a much more conservative approach in the 10 years to come, having 70% of their money in bonds and just 30% in stocks, Vanguard said on Tuesday. The firm’s Vanguard Asset Allocation Model, which aims to predict decadelong returns based on starting valuations, says that’s the most favorable allocation at the moment.
“The ongoing strength in equities reinforces Vanguard’s case that bonds are attractive relative to US stocks, which we anticipate will offer returns below their long-term historical averages over the next decade,” Vanguard said in the report.
“The U.S. equity market continues to trade well above the top end of its fair-value range,” the asset manager added.
Vanguard said stock valuations, which are strong predictors of long-term performance, are elevated by at least a couple of measures as the market continues its nearly three-year bull market run.
For one, prices are high relative to a rolling average of inflation-adjusted earnings over the last 10 years, Vanguard said. Also known as the Shiller CAPE ratio, the measure shows stock valuations are at levels rivaling 2021, 2000, and 1929. Stocks dipped into painful bear markets in the years following these peaks.
Second, the equity risk premium is historically low. That means assumed future returns on stocks, based on valuation levels, are unattractive relative to risk-free bond yields.
Vanguard expects US equities broadly to return just 3.3% to 5.3% a year on average over the next 10 years. Bonds, which generally have a lower risk profile than stocks, should deliver 4%-5% a year, the asset manager said. Yields on 10-year Treasury notes currently sit at 4.2%. Higher yields tend to weigh on stock performance and valuations as investors seek to secure risk-free, robust returns elsewhere.
Again, these forecasts are over a 10-year period. For those with a longer timeline, like 30 years, Vanguard sees stocks outperforming.
Either way, the firm said its asset allocation model shouldn’t be taken as a one-size-fits-all recommendation.
“The TVAA portfolio is intended to be informational, free from real-world constraints such as trading costs and tax consequences of recalibrating the portfolio,” the firm said. “An investor’s goals, risk tolerance, tax situation, and preferences are important factors in determining whether the TVAA portfolio is suitable for implementation.”
Read the original article on Business Insider
