Preparing For A Golden Retirement

Conventional wisdom has stated that a 60% stock, 40% bond asset allocation was a safe and reliable path to accumulate wealth. In years past, this was true, but in these current times where the interest rate on the 10-year Treasury bond is at 0.74% there is a need to reevaluate. Federal Board Chairman Jerome Powell introduced a fed policy on August 27th, 2020 that all but guarantees that interest rates will not grow for at least 3-4 years.

Stock Portfolio balanced by US Treasury Bonds

Here is a chart that shows the compound rate of growth of various stock/bond portfolios in each of the past 25 decades. The decades range from the 10 year period 1986-1995 through the decade of 2010-2019. The stock portfolio used is the Dow Jones Industrial Average. The bond portfolio used is the 10-year Treasury bond. To equalize the playing field, all dividends are reinvested and so is the interest from the bonds. These portfolios are rebalanced yearly, at the start of the year. There are four data points for each mix. The orange x shows the median growth rate for the various mix of stocks and bonds. The blue x shows the 75th quartile, meaning that only 25% of the decades exceeded this number. The grey x shows the 25th quartile, which means that only one quarter of the decades had a worse return. The yellow x highlights the worst performing decade.

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

Notice that returns of most decades fall as a greater and greater percentage of bonds are added to the stock portfolio. However, in the worst performing decade, the minimum return grew each year except when the whole portfolio was invested in 10-year bonds. It seems that a total bond portfolio is the worst performing portfolio mix shown. The only stock mix that performed significantly worse was the 100% stock portfolio, and that was only for one of the 25 decades listed.

Median performance is arguably the best predictor of what kind of return to expect. The median, bottom 25%, and top 25% of decades all decreased as the percentage of bonds increased. When looking at this chart, the logical question is “How much growth am I willing to give up to guard against a terrible decade of stock performance?” Except for the worst decades, every dollar in bonds sacrifices the total return of the portfolio without providing much of a safety net. Keep in mind that over all these decades, the Dow Jones Industrials never had a negative return, with dividends reinvested.

This data covers the timeframe from 1985 to 2019. Next, I will show the detail spreadsheet that was used to derive the chart shown above:

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

The green cells show the top 25% returns for each portfolio mix. The red cells show the bottom 25% returns for each mix. The last column shows the annual return for the 100% 10-year Treasury portfolio. Notice how the returns have steadily declined in each successive decade (other than a minor increase in 2018). Also notice that all of the top 25% returns for a bond portfolio were prior to 2000, regardless of the mix of stocks and bonds. This is because stocks had their best performing decades ending from 1995 to 2000, and bonds yielded their highest rates in these same periods. In none of the past 15 decades has the 60% stock, 40% bond portfolio provided a 10% return even though the stock market had returns of around 13% in the most recent 2 decades. With the Federal Reserve policies introduced by Jerome Powell, we can conclude that the interest rates will not rise until at least 2023.

Stock Portfolio balanced by Gold

Let’s use the same analysis and compare various portfolios of stocks and gold. For stocks the same Dow Jones Industrial Average is used, with dividends reinvested. For gold, the spot price of gold will be used at the start and end of each decade. No transactions costs will be considered for either investment. For this chart, I included 29 decades spanning the years 1972 through 2019. I started in 1972 because the price of gold was fixed to the dollar until that time.

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

This chart looks much different than the corresponding chart of stock and bonds. First notice that a 100% gold allocation provides terrible returns in the worst of times. In the decade ending 1997, gold had a return of -5% annually. In 25% of the decades, gold had a negative return. Gold by itself is a poor investment. However, when gold is added to a stock portfolio, it has a more positive affect than a stock/bond portfolio. An 80% stock, 20% gold portfolio provided a 4% annualized return in the worst decade (1999-2008). If the gold portion was increased to 40%, the worse decade earned a 6.17% annual return. As the gold portion increases, the top returns decrease. If someone wanted stable appreciation with minimal risk, a 60% stock and 40% gold portfolio is an excellent choice.

A Comparison of Bond and Gold in a Portfolio

Below is a chart comparing the returns of a 40% bond portfolio with a 40% gold portfolio with 60% invested in the Dow Jones Industrials.

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

The stock portfolio balanced by 40% bonds outperformed the 40% gold portfolio in the top quartile by 0.46%. However, in all the other quartiles, the gold portfolio did better than the bond portfolio. The gold portfolio had a median annual growth of 9.71% compared with a median rate of 8.10 for the bond portfolio. In this same gold portfolio, the difference between the top quartile and the worse decade performance is 4.67%. By that same metric, the bond portfolio difference is 8.48% making the bond mix more volatile. I would be willing to give up the better performance of the top quartile of the bond portfolio, for the stability of the gold. If someone showed me these charts without labels, as a retired person, the chart on the left is a more predictable selection. There is much more volatility with bonds as shown in the chart on the right. As a person ages, volatility becomes an enemy where stability is a friend.

When a person retires or is close to retirement, it becomes important to look at the worst-case scenario. The worst decade for a 40% gold portfolio was a 6.17% annual growth rate. Compare that with the 2.82% growth rate for the 40% bond portfolio.

Here is the detail spreadsheet for the stock/gold portfolio.

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

The percentages are the annual percentage rate increase of the portfolio over each decade. The first column is the ending year of the decade. The second column is the performance of 60% stocks/40% bonds. The third column is the performance of 60% stocks/40% gold. The fourth column is the difference. A positive difference means that gold outperformed during that decade. A negative number means that the bond mix did better than the gold mix. The last column is the annual return of a 100% bond portfolio.

As discussed above, a 100% gold portfolio or a 100% bond portfolio performed poorly in many decades. If stocks are not included in a portfolio, huge potential growth in the market is left on the table limiting future returns. But, bonds and gold are both a hedge against a poor performance in the stock market, which has happened in past decades.

Here is a comparison of 40% Gold to 40% bond allocation in a 60% stock portfolio for each decade:

Source: Steve Shea, data from the spot price of gold and TD Ameritrade

This data supports a fascinating theory. It would appear that if the bond yields are over 5%, bonds are a superior investment as a hedge against stocks. If bond rates are below 5%, gold is a better hedge.

This isn’t a perfect correlation. If it was, the differences between gold and Treasuries would increase as the bond yield decreases. Gold is a free market commodity. The price fluctuates with production, demand, global uncertainty, and other factors. Interest rates are controlled by the Federal Reserve. Thus, there isn’t a free market discovery for the price of money. No investor I know would accept a 0.7% annual yield on a 10-year Treasury bond. But that is the current yield on the 10 year Treasury.

An obvious conclusion is to invest in gold when the 10-Year yield is low. The Federal Reserve has gone on record stating that they will not raise interest rates for the next few years.

Why a Stock/Gold Portfolio Works

If $10,000 was invested in the Dow Jones Industrial Average on January 1, 1914, and all dividends were reinvested, it would be worth $268,923,501 on December 31, 2019. I recognize that no one can live long enough to enjoy those returns, but the trend is definitely up. This is a 10.1% annual return over a period that included 2 world wars, 2 depressions (one lasting over 10 years) many recessions, periods of inflation and deflation, and many periods of democratic rule, republican rule, and times where the house, senate and executive branches were divided. I chose 1914 as the start of this trend because in that year, the Federal Reserve was created and it was also the start of income tax in America.

$10,000 invested in gold on January 1, 1972 would be worth $348,378 on December 31, 2019, which is a 7.67% annual growth rate. While the growth rate isn’t as good as stocks the trend is positive. The Bretton Woods agreement at the end of World War 2 pegged the US dollar at $35 to an ounce of gold, and other currencies (Canada, Western Europe, Australia and Japan) would price their currencies against the US dollar. In 1971, President Nixon untethered gold from the US dollar. It is beyond the scope of this book to investigate that decision, but suffice it to say this event contributed to never-ending increases in sovereign debt and constant decreases in the value of the dollar. This is the reason I chose 1972 as the start date for the gold investment. As with stocks, gold trends upwards over a long time.

A 10.1% rate of growth is much better than 7.67%. Why not put 100% of investments in stock? Because it is prudent guard against a long, protracted period of negative returns for stocks. If funds were invested in stocks on January 1, 1929 (just prior to the great depression) it would have taken until December 31, 1944 for those funds to return to starting value, and this includes reinvesting dividends. Over that timeframe, it would have been better to hide your dollars under the mattress. Is there a more recent example? If you invested $10,000 in the Dow Jones at the start of this century on January 1, 2000, it would have been worth $9,321 nine years later, again with dividends reinvested. This is another time when it would have been good to stash money under the bed. It is pessimistic to highlight the worst two investment periods in the last century, but also practical. These terrible decades happened in the past, and they can happen again. Worse, we don’t know in advance when this type of decade will be in front of us. A person close to retirement must guard against this destruction of wealth. Although a younger person has enough earnings potential to recover from this devastating loss, it would be better if he too was able to avoid it.

Slow and steady wins the race. Historically, stocks have had the best returns of any asset class. But there have been some decades where the returns were abysmal. The best way to protect against those poor decades is to balance stock investments in different, non-correlated assets. Gold is not positively or negatively correlated with stocks. This means that if stocks go up, this gives no indication on the price of gold in that same period. Over a long horizon, it would be beneficial if those two asset classes were trending up. Gold and stocks are two non-correlated asset types that trend upwards, which makes them a great combination for long term growth, even in this economic reality.

Disclosure: I am/we are long PHYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.