401(k) changed

Investors, we’re not in Kansas anymore.

For four decades, patient savers able to grit their teeth through bubbles, crashes and geopolitical upheaval won the money game. But the formula of building a nest egg by rebalancing a standard mix of stocks and bonds isn’t going to work nearly as well as it has.

Now, longer-term Treasury yields have hit their highest levels in 16 years, causing their value to plummet, and stocks are expensive. So investors need to lower their expectations and play defense.

The summer of 2020 was the point when the classic “set it and forget it” stock-and-bond portfolio was as good as it got. Investors who didn’t panic earlier that year when Covid-19 crushed stocks cheered the quickest return to a bull market in history. Likewise, long-term Treasury yields plunged to a record low, bolstering bond funds. A classic 60/40 stock-bond split owning that proportion of the S&P 500 index and 10-year Treasury notes earned a respectable 15.3% in 2020.

But there are few free lunches in finance. Squeezing those impressive returns out of a worldwide economic calamity added to the U.S. government’s already considerable bill after the global financial crisis. Federal debt held by the public mushroomed from less than $5 trillion in mid-2007 to more than $21 trillion in 2020. Meanwhile, overnight interest rates were pushed down to a once-unthinkable zero percent, where they would stay until early 2022.

That combination attracted millions of new stock investors: Young people, stuck at home during the pandemic with extra savings, opened brokerage accounts and initially ran circles around their elders. The “buy the dip” mantra that had served investors so well took on an obscene modifier with the acronym “BTFD.”

Suddenly the best investments were in companies that were earning little to no money but had a great story about how they would one day. By January 2021 an index of unprofitable companies maintained by Goldman Sachs had rallied nearly 300% in nine months. Junky investments had posted gaudy returns before, and it was usually a sign that money had become too cheap. It had never been free, though.

By last year, the massive budget deficits and zero-percent interest rates had stoked the highest inflation in 40 years. This forced the Federal Reserve to play catch-up through a series of rate increases.

The last time inflation became so high it stubbornly stayed there for years. The Fed finally broke its back by pushing overnight interest rates above 19% in 1981. Interest rates’ long descent over the next four decades, along with a general disgust with stocks that had left them at their cheapest in half a century, were the wind in markets’ sails.

An investor who put $1,000 into a 60/40 portfolio at the end of 1981, even after adjusting for inflation, had $18,728 by the end of 2020. The portfolio would have lost money in only five of those years. No wonder even pros on Wall Street treat a classic balanced portfolio like gospel.