Investing in the 2020s

Why the 60/40 approach will not make you stand out

This article is not investment advice. The only thing I advise you to do is think for yourself and make your own decisions.

For the lazy folks. Here are my three arguments on why the 60/40 ETF investment strategy is mediocre.

It is designed to reduce volatility and protects individual investors from their own biases. You pay a premium for the “protection mechanism”.
It lacks individual assessment of the investor’s financial wants and needs (Duration, Risk & Return) — does it fit your wants and needs?
It is backwards looking. In what kind of world do you think will we live in a decade or two? New technologies provide massive opportunities for those who understand them from first principles and are willing to infer and invest.

Here is the whole Story:

My best friend recently texted me this:

Yesterday I watched a video about scientific studies suggesting that active investment (Stock picking) is worse than passive investments (ETFs) over 10–20 years. This was super interesting because it says that active investors are overconfident by thinking that you can outsmart other investors. But the numbers prove them wrong.

I was about to send him a voice message explaining why I think these statements are flawed and show why the investment community, especially in Germany, needs to stop inferring from the past.

Instead of recording the voice message, I decided to write an article. I watched the video and tried to summarise the arguments they brought up.

An individual should try to predict their Lifecycle and create a concept where you try to predict how much money you will save for each phase of the cycle. Based on the assessment, you plan your phase of investment and your phase on consumption.

Nothing wrong with this approach. In addition you should ask yourself — why do I even think about “investing” in the first place? What do I want to achieve? Try to be as precise as possible.

Build an ETF Portfolio based on the 60/40 rule. This means that you invest 60% of your capital into stocks, and 40% goes into Bonds. Both asset classes will be represented in ETFs, where you buy a basket of different Entities (Companies, Governments). The underlying assumption is that we live in a world of Efficient Markets, where all information are included in the price. So there is no possibility to outperform the market, and by the way, “you don’t know-how is going to win.” — so why even bother. Adding Bonds to the Stock Portfolio is an excellent hedge against volatility in the Stock Market.

What am I trying to achieve by pursuing a strategy like this?

We often forget that the fundamental assumption for recommending a strategy like this is based on individuals looking for a balanced investment strategy, where they try to balance risk and return to find an optimal risk to return profile. At least, that is what financial education and the portfolio theory tells us. And there comes to the fundamental problem:

We forget to ask the question: What is risk and what is return for the individual?

Risk and return are both concepts that were standardised, defined to make them measurable. Risk is often described as volatility, which is the percentage of a change in price over a period of time. Return is usually defined as the amount of surplus at the moment where you decide to switch assets. For example, you sell your stock and transfer it into a fiat currency like EURO or USD. If you get more EURO after selling than you previously paid, you made a return.

Often there is this discrepancy. Risk is detached from the actual selling process, while return is attached to the selling process. I treat both the same way. I do not care about temporary “losses” im my Portfolio.

If I, for example, try to optimise for a low volatility portfolio with moderate returns, I implicitly prepare myself to liquidate my portfolio at almost any point in time. This optimisation process and the 60/40 Portfolio is kind of the shoe that fits everyone principle.

Advisors tempt to suggest this because

a) they do not want to assess the individual’s personal risk/return and investment period or

b) Individuals cannot articulate and plan their preferences for the investment period and risk profile.

Both lead to such concepts that are “okay” for most people. Still, by definition, most people will adopt what fits most people, which will be adopted by most people, leading to mediocre results for most people.

Individual stock picking is a terrible idea because the field of behavioural finance shows that individual investors are often biased (overconfidence or home bias, to name a few). Also, there are so many analysts who already covered the stock. There is no more information left that is not already priced in. Stock picking is based on FOMO and the principle of the greater fool. This means people are greedy and buy into stock bubbles hoping to find a greater fool to sell the stock to, before the bubble pops.

Biases are natural, and individuals tend to make biased decisions. Buying into the hype because of pure greed is both a problem. This happens, and individuals lose money.

Becoming a good investor means developing self-awareness and discipline. Claiming that stock picking always loses compared to buying “the market” is an undifferentiated and simplified view on investing. Arguing that analysts already figured it out and all the information is priced is both is a bold statement and probably will not age well.

I didn’t research the topic, but my gut feeling tells me that most analysts tend not to predict prices but instead adjust their prices afterwards. They follow reality.

We need to challenge the idea of widespread clear reasoning. Do we believe that all investors have the same level of understanding of individual companies?

Conclusion

Recommending an investment strategy based on broad diversification and not allowing individual decisions is an attempt to prevent individuals from becoming clear thinking beings that assess, analyse and infer.

Arguing that all information is already priced was probably less wrong 20 years ago, where most products and services created by human beings were simple and easy to understand for most people.

In our current day and age, we live in a world of so many emerging technologies that most people do not understand from the first principles. Even stock analysts are massively overwhelmed by technological change. So it’s up to the individual to decide which path to take.

a) Do not try to think by yourself. Do not assess ideas, technology, concepts and keep making investment decisions based on backwards-looking heuristics and strategies like the 60/40 approach.

b) Do the homework. Try to understand technologies and business models. Research, understand and make decisions based on conviction and knowledge.

I build my portfolio based on a tiny amount of companies or protocols, where I am convinced that they are or will become great companies and find mass adoption in the future.

I hope sharing my thoughts on this topic was helpful.

Best

Willi

PS: Thank you for reading this article. You are awesome.