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Asset Allocation Dispatches

Asset Class Group Returns: Short-Term Bonds Lead During a Rough Year

The year 2022 was a tough one for asset allocators as returns were down across the board.

by Charles Rotblut | February 2023

Charles Rotblut leads a class in AAII's new Essential Investing Video Course. Go to https://www.aaii.com/ves for more information and to subscribe.

Figure 1 shows an updated “heat map” for the seven asset class groups that comprise the AAII Asset Allocation Models. (The models can be viewed at www.aaii.com/asset-allocation.) This heat map ranks each asset class group by its calendar-year performance in descending order from left to right. The groups are color-coded so you can track their relative performance over time.

Last year was a tough one for asset allocators as returns were down across the board. Both stocks and bonds fell as inflation rose globally. This was just the sixth time since 1878 that both stocks and bonds experienced negative returns in the same calendar year, according to The Leuthold Group.

Short-term bonds had the “best” performance last year, losing just 4.7%. This was the second time in five years that short-term bonds have led.

Mid-cap stocks, conversely, had the worst comparative returns. This is the first time in at least 16 years that mid-cap stocks have finished last. Perhaps true to their name, mid-cap stocks have also only led once in the past 16 years, in 2016.

FIGURE 1 Annual Returns for Each Asset Class Group (2013–2022)

There can be a tendency to look at last year’s returns and conclude that diversification is broken or doesn’t work. This is not the case. Diversification simply had an unusually bad year. Over longer time periods, diversification helps to reduce the volatility of a portfolio’s returns.

Diversification also reduces the risk of being wrong by increasing the odds of being allocated to the right asset class group at the right time. As the heat map shows, there has been a lack of consistency among each year’s best- and worst-performing asset class group.

Longer time periods smooth out the year-by-year fluctuations you see in the heat map. Over longer periods, stocks provide long-term growth of capital while bonds—particularly when held to maturity—provide preservation of capital. This difference allows them to complement each other within the context of a diversified portfolio.

Ultimately, your goals and tolerance for risk should drive your allocation decisions, not recent performance data or expectations of what will happen next.

Discussion

CRAIG B from WI posted over 3 years ago:

Despite being in mostly short-term bonds, I still lost principal in 2022. My Vanguard VMFXX Federal Money Market now yields 4.61% and rises with the 2-Year Treasury note, inversion and all with NO loss of principal. Safe, secure and rock-solid (relatively speaking, of course!) the only downside is losing the state tax deduction. The deduction is secondary to growing and keeping my money, particularly principal in my "safe" part of my 3 Bucket System. I use mutual funds and ETF's as I simplified my portfolio to make it easier for my wife to manage when I one day leave this earth. In my situation, VMFXX cannot be beat for my Bucket #1 / Safe money and I'm holding more cash than I ever have due to my age and market/economic conditions, still ready to deploy more into my allocations once the Fed stops raising interest rates.


David H from SC posted over 3 years ago:

Federal Money Market Fund 37.79. This is the percentage from US goverment obligations on the Vanguard website. Important tax information for 2022 This tax update provides information to help you properly report your state and local tax liability on ordinary income distributions you received from your mutual fund investments in 2022. On the next page, you’ll find a list of Vanguard funds that earned a portion of their ordinary dividends from obligations of the U.S. government. Direct U.S. government obligations and certain U.S. government agency obligations are generally exempt from taxation in most states.*


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