The 60/40 portfolio is dead! Articles with this headline hit the financial media circuit at least once a year.
When volatility spikes or interest rates rise, speculative investment managers tend to use it as an opportunity to question a timeless approach amidst short-term uncertainty.
Because losses in your portfolio (and years where both stocks and bonds are generally down) can be especially difficult to stomach, these pieces can feel intriguing, but let’s take a quick step back.
What is a 60/40 Portfolio?
A 60/40 investment portfolio is made up of “60% stocks and 40% bonds.” The term has become a synonym for a “balanced portfolio,” balancing risk tolerance between stocks and fixed-income securities.
That said, using it as a blanket term can be misleading because there are many ways to build a 60/40 portfolio to maximize diversification, and many quick reaction articles don’t accurately represent a modern approach to diversification like we embrace here at Plancorp.
Assumptions: Comparing Apples & Oranges
The first assumption within many of these articles is that the stocks portion of every 60/40 portfolio is invested flatly in the S&P 500. If this were the case, there may be more merit to the argument it’s outdated, but this is not what we recommend.
Instead, the last few decades of research have encouraged long-term investors to spread stock exposure with tilts toward value, small caps, profitability, as well as international markets through understanding how asset classes impact returns. (Check out our guide to asset allocation models for more information). A basic S&P 500 portfolio may struggle to produce returns as it has in the past, but these articles often miss the mark on what your 60/40 portfolio may contain, especially if you are a Plancorp client.
Similarly, the second assumption is that the bonds portion of a portfolio is only made up of basic treasuries, which we also do not recommend. Expanding beyond simple Treasuries and diversifying duration and average maturity decreases the likelihood of experiencing significant declines.
For example, shorter term bonds (like the ones held within many of our client portfolios) are generally less impacted during volatility. Even when they do lose some value (like this past year) it doesn't mean they won't pay higher yields going forward.
In the case of recent bond market declines, they are mostly attributable to record-breaking rate increases coming out of the Fed, not a signal that the asset class should be scrubbed from smart portfolios entirely.
The third assumption is that one can easily outperform a 60/40 portfolio by actively managing it with the use of derivatives, alternative investments, hedge funds, and private equity. It is Plancorp’s perspective based on decades of academic research that short term, expensive, speculative bets (derivatives, hedged funds, private equity, etc.) do not give long term investors a better chance at producing better risk adjusted returns. Take a look at our a blog on the Failure of Active Management, and learn more about the Active vs. Passive debate here.
Long story short: critiques rarely take into account the realities of a portfolio labeled 60/40, but constructed with deeper levels of diversification.
We agree that an investor who has coasted with a simple S&P 500 / Treasury portfolio should consider making changes. But the portfolios we recommend are diversified at a much deeper level than between stocks and bonds.
Reducing losses through diversification and portfolio construction is as important to us as engineering exposure to parts of the market (small and value) that are expected to outperform the broad market over long periods.
Understanding the 60/40 Portfolio
The 60/40 portfolio has long been revered for its balance between growth and stability.
The 60% allocation to equities allows for participation in the potential upside of the stock market, capturing long-term growth. Meanwhile, the 40% allocation to bonds acts as a stabilizing force, providing a cushion during market downturns and generating income through interest payments.
Pros of the 60/40 Portfolio in 2023:
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Diversification: The blend of equities and bonds provides a diversified exposure, reducing overall portfolio risk. Although, as mentioned, there are even deeper levels of diversification to pursue.
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Income Generation: Bonds contribute to the portfolio's income stream, offering a generally more reliable source of cash flow even in turbulent market conditions.
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Risk Mitigation: The inclusion of bonds acts as a buffer during market downturns, helping to cushion the impact of equity market volatility.
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Considerations:
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Higher Interest Rate: The income generated from the bond component may fluctuate depending on interest rate levels, impacting overall portfolio returns.
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Changing Market Dynamics: The investment landscape is evolving, with factors like technological advancements and shifting global dynamics influencing market behavior. Traditional models, including the 60/40 portfolio, may need periodic reassessment and rebalancing to ensure relevance. If you DIY your investments, don’t assume a 60/40 portfolio set even a year ago is still aligned with your tolerances.
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Inflation: Rising inflation can erode the real returns of bonds, affecting the overall performance of the portfolio. Working with a professional can help ensure other aspects of your portfolio help hedge against inflation.
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Investment Objectives, Resilience & Your Investing Narrative
In times of uncertainty, constructing a financial narrative that aligns with long-term objectives is paramount. Why are you investing, and what are you investing for?
The 60/40 portfolio, with its time-tested principles, offers a blueprint for investors to navigate through the complexities of the market, not try to game above it.
Short-term losses, though inevitable, should not overshadow the broader narrative of wealth accumulation and financial security. More than ever, we recommend maintaining a disciplined approach to long-term investing going into 2024. Staying true to proven principles often leads to lasting success and be wary of those offering solutions that purport to “beat” the market.
The Long Term Investor Episode 76: Is the 60/40 Portfolio Dead? [Podcast]
As proof of how this narrative springs up in financial media regularly, our Chief Investment Officer Peter Lazaroff CFA, CFP® covered the topic in an episode of his podcast The Long Term Investor last year.
A brief 14-minute listen, Peter covers the context around 60/40 portfolio performance through past volatile time periods as well as insightful rebound performance after declines. In short, he busts a lot of myths about the 60/40 portfolio that are worth your time. You can listen to the full episode here.
If you’re feeling uncertain about your investment strategy or overall financial plan, we’d love to help. Test your plan using our free financial plan analysis to see what a aspects a financial advisor can help with, and where you might be ready to move beyond basic investment advice.
Disclaimer: This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.
