Do The Old Rules Now Apply Again?

Patrick R. Cote CFA, CFP® |

By: Patrick R. Cote CFA, CFP®

“The rules no longer apply.”  Spring 2020 – As the Covid pandemic took off, I found myself repeating this phrase with my teenage sons, as they were shocked to see many of the activities and organizations they knew shut down or shifted to virtual meetings.  The investment world also went through a lot of upheaval during the pandemic, with the overall decline, the quick turnaround, the rise and fall of tech stocks and the large increase in commodity prices.

For the decade prior to the pandemic, the investment world faced another anomaly, with historically low interest rates driven by central banks around the globe.  The Federal Reserve kept short-term rates to 1% or below for most of that time, which helped boost stocks and bonds while rates were low.

We are now seeing both of those unusual situations coming to an end, with much of the world more or less moving past the pandemic and both inflation and interest rates starting to go up in the US and many other countries.  This now means that it might be time to dust off some investment rules of thumb that had been put on hold:

  1. Invest 110 less your age in stocks – the idea was that as we age, our portfolios should become more conservative, with less in stocks and more in bonds.  This rule was originally 100 less your age in stocks, however, as people began living longer, it was changed to 110.  However, as bonds had lower yields over the last decade, it became less attractive to have a large proportion of your portfolio in bonds.  For a 65 year old, putting 110 – 65 = 45% in stocks and 55% in bonds (which were paying <2%) was not particularly attractive.  Many investors ended up increasing their allocations to stocks to compensate for the lower bond yields.
  2. The 4% Withdrawal Rule – the idea was that if you are age 65, you would likely be OK withdrawing 4% of your savings/investments for the rest of your life – you would not likely outlive your money.  It was hard to make this rule work when bonds were paying <2% each year.  The rule had to be adjusted downward to compensate for the lower yield, so some estimates lowered it (e.g., the rating agency, Morningstar, reduced it to 3.3%).
  3. Overweight small cap and value stocks because they outperform over long periods of time – Prior to 2009, research had shown that both small cap and value stocks tended to outperform large cap and growth stocks over long periods.  However, since 2009, US large cap, particularly growth stocks, have been one of the top performing assets, driven by the well-known FANG stocks – Facebook (now Meta), Apple, Netflix and Google (now Alphabet).  Both low interest rates and the pandemic helped create this effect.

Now that we seem to have moved past the pandemic, we are seeing how some things may have changed permanently.  For example, many of us can now work remotely for at least some of the time.  However, at the same time, there is a sense of relief at being able to do some of the things we all missed during the pandemic.

For investing, it is not clear whether we can go back to the old rules of thumb just yet.  With the 10 year yield on bonds at 3.4% and inflation at 8.6%, it is still not very attractive for a 65 year to have 55% in bonds.  That investor would also not likely be safe to withdraw 4% of their savings/investments each year just yet.

At a 9% decline, we have seen value stocks do much better than growth stocks (down 26%) so far in 2022 – that is a large shift from the outperformance of growth stocks in recent years.  We are seeing similar declines in large cap and small cap stocks (down 22% - 24% YTD, depending on the measure), which is also a shift from the recent outperformance of large cap stocks.

The bottom line – it looks like the old rules do not apply again quite yet.  However, it will be important to keep an eye out as market conditions change.