Reports that the 60/40 investment portfolio is dead may have been grossly exaggerated.
This conventional formula governing how much of your nest egg should be divided between stocks and bonds clocked one of its worst years in over a decade in 2022 when both asset classes tanked at the same time.
That led some to speculate that the old mom-and-pop strategy may have run its course. Since then, though, the old standby approach has taken off due to bouncebacks in both stocks and bonds.
The 60/40 portfolio has recorded a 22.15% return from January 2023 through the end of June this year, according to Vanguard senior investment strategist Todd Schlanger, who is bullish on the future of this strategy.
Stocks rallied on enthusiasm for the potential of artificial intelligence and growing confidence the US economy will stick a soft landing. Bonds jumped on expectations for eventual interest rate cuts from the Federal Reserve.
“It’s been that kind of consistent performer in the past because of its diversification,” Schlanger said. “You’re never going to see it at the top in terms of performance and it’s never going to be at the bottom either.”
“It’s a very diversified strategy and we think it’s poised to do very well in the future,” he added.
‘The all-weather portfolio’
The classic 60/40 strategy refers to a long-held approach of holding 60% of your investment portfolio in equities and the remaining 40% in fixed income. Traditionally, bonds are used as a portfolio’s shock absorber, often rising in value when stocks are down.
To further diversify that portfolio, the investments within the equity and fixed income portions are spread among US and international markets, Schlanger said.
The breakdown looks like this: The standard portfolio would have 60% of its stocks in US equities and 40% in international, weighted by market capitalization.
In the fixed-income component, 70% is allocated to US bonds and 30% are global bonds.
“I think of it like the all-weather portfolio because it’s so diversified,” Schlanger said.
Steady, not necessarily outsized, returns is the key. Over the long term, the 60/40 has provided that consistency.
Since 1997, the average return has been 6.7%. And in the last decade, the return was 6.2% “even including 2022,” Schlanger said.
‘One of the worst years’
But 2022 served as a major challenge to the primacy of this approach. That year, the 60/40 portfolio declined by almost 16%.
Rapidly rising inflation, which peaked in June 2022, clobbered both stocks and bonds. The S&P 500 lost over 19% in value, while the Nasdaq plunged 33% as the Fed hiked its benchmark interest rate in response to inflation, making borrowing costs for companies a lot more expensive.
At the same time, US bonds posted their worst-ever year on record as a result of the central bank’s aggressive inflation-fighting campaign.
All that took a heavy toll on the 60/40 portfolio.
“It’s not unusual for equities and bonds to fall at the same time … typically in periods of inflation,” Schlanger said. “But by 16%, that is one of the worst years we’ve seen for a balanced portfolio like the 60/40.”
‘A much more balanced outlook’
But one bad year shouldn’t dissuade investors from the 60/40. In fact, Schlanger believes the standby portfolio is again positioned for a good run over the next decade.
While equities propped up the average return of the 60/40 in the last 10 years because bond returns were “below average” — yielding just 2% during that time — bond yields are much higher now.
“Going forward, we expect bonds to play a more significant role in the return,” Schlanger said. “It can be a much more balanced outlook.”
With all that said, the 60/40 portfolio is not for everyone. Someone’s risk appetite and age play a big role too.
For instance, Vanguard’s target date funds for someone in their 20s would allocate 90% of their portfolio to riskier equities, Schlanger said, because they have a longer time horizon to make up for any down years in the stock market.
But someone in later retirement would have only 30% of their portfolio in stocks because bonds offer less risky returns.
“Investors go through different life cycles and their risk tolerance evolves with time,” Schlanger said, “and so we’re not here to say that the 60/40 is right for everyone.”
Janna Herron is a Senior Columnist at Yahoo Finance. Follow her on Twitter @JannaHerron.
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