“In theory there is no difference between theory and practice. In practice there is.”
— Yogi Berra

The same thing applies to choosing an investment strategy that you can actually live with.

In theory, investors often claim to be able to handle the market volatility that inherently comes with a more aggressive portfolio. But that may not hold true when markets tank.

And history is littered with investors who got scared when markets fell dramatically (as they have so many times over the years) and sold out only to lock in big losses.

So, finding the right strategy — a mix of stocks, bonds and cash — that seeks the returns needed to meet your goals at a level of risk you can tolerate is essential.

Note I said “tolerate” — not enjoy. As Vanguard founder Jack Bogle once said, “if the fluctuations in your investment portfolio are reduced, the impact of emotions and behavior on your account is also reduced.”

While a well-diversified portfolio may include a larger “menu” of investment options, I’d like to focus the conversation on just two — stocks and bonds.

Let’s use the S&P 500 as a proxy for stocks — and the Bloomberg Barclay’s Aggregate for bonds. Then consider a range of different stock/bond mixes — ranging from 100% stocks to 100% bonds — with a 60% stock/40% bond mix in the middle.

The portfolios we constructed over the years for clients typically ranged from 70/30 to 40/60 stock/bond mixes — with just a few more aggressive or conservative.

It is expected that stocks will deliver higher long-term returns — but come with some fairly significant volatility.

Bonds are expected to deliver lower long-term returns, but with more steady income and a lot less volatility.

And perhaps most important, we expect what statisticians call “negative correlation” — or simply, that when stocks go down/bonds go up and vice versa.

But 2022 saw significant declines in both stocks and bonds, leaving investors to question whether this is true — and “recency bias” can make folks wonder if this “negative correlation” still exists.

So, consider some facts:

• Bonds have had negative returns in only four of the past 25 years. -2.92% (1994), -0.82% (1999), -2.02% (2013) and -13.01% (2022). The 2022 decline was due to sharp interest rate increases from the near-zero rates of the prior decade as the Fed fought inflation.
• Stocks have had negative returns in eight of the past 25 years. -5.10% (1981), -4.21% (1990), -7.79% (2000), -12.45% (2001), -21.65% (2002), -37.60% (2008), -4.78% (2018) and -19.13% (2022). Not only more negative years, but some heavy decline amounts.
• A 60/40 stock/bond mix had negative returns in seven of the past 25 years. -1.10% (1981), -0.02% (2000), -4.11% (2001), -8,89% (2002), -20.46% (2008), -2.87% (2018), -16.68% (2022).
• Over the past 25 years, there has never been a three-year span of losses in both stocks and bonds.

So, while a 60/40 stock/bond mix did not preclude years with negative returns, bonds did in fact serve as a buffer against stock market risk — “smoothing out the ride.”

And while the -21% downturn in 2008 of a 60/40 mix was truly awful, imagine watching your portfolio lose almost 40% of its value if you held a 100% stock account.

I had grown men in my office literally in tears during the Great Recession — terrified they were going to “lose all their money.”

My advice then (difficult to give/difficult to take) was to “stay the course” and ride out the market storms in the moderate-risk/well-diversified portfolios we had built for them.

Fortunately, all but a handful out of hundreds of clients reluctantly took that advice — and within about 18 months their portfolios had returned to prior values.

The few who had demanded we sell out suffered irreconcilable losses as they watched the rocky recovery.

But the Fed’s aggressive actions in trying to tame inflation resulted in big declines in bonds (13% in 2022) — causing investors and some market pundits to declare the death of the 60/40 portfolio.

Bond math is simple — it works like a teeter-totter. When interest rates fall, bond prices rise — and vice versa.

So, the rapid and steep rise in interest rates hit bonds hard in 2022. But many (including me) think like the phoenix, the 60/40 portfolio will rise again.

According to Vanguard, the annualized return of a 60% U.S. stock and 40% U.S. bond portfolio from Jan. 1, 1926, through Dece. 31, 2021, was 8.8%.

Going forward, Vanguard models project the long-term average for a 60/40 portfolio to be
around 7%.

Recent rate hikes now leave bond yields in the 4% to 6% range — quite attractive with inflation on the mend and after a decade of near-zero yields.

Vanguard goes on to say “market volatility means diversified portfolio returns will remain uneven, comprising period of higher or lower — and yes, even negative — returns.

And of course, there are no guarantees of future results.

Note that while I have focused on the 60/40 mix because of its long history as a benchmark, there is nothing magical about this mix.

For some investors with a longer time horizon, the right strategy might be a more aggressive 80/20 or even 90/10. For others who are closer to retirement or more
conservative-minded, perhaps a 40/60 or even 30/70 mix might be the right choice.

Whatever the target mix and whatever you decide to include in the portfolio (i.e., foreign or emerging markets, REITs, commodities, etc.), success demands long-term discipline.

And as I have stressed in this and other articles, that means sticking with your plan and not allowing natural human emotions to cause you to go off course. This isn’t just theory — it takes practice.