Over the past decade, I have read countless articles and prognostications calling for the “death of the 60/40 portfolio.” The 60/40 is an investment portfolio holding 60% in stocks and 40% in bonds. I honestly can’t keep track of how many articles like this one from 2019 I have come across. According to this author, the 60/40 actually “died” back in 2016! No, wait—this investment organization called for its “death” back in 2009!
I don’t mean to poke fun, but bold statements like these are silly because almost no one can accurately predict such a thing.
The truth is, the predictions were all wrong and will continue to be wrong over the long term. Yes, there will be periods where a 60/40 underperforms, but you will be hard-pressed to find a better long-term, risk-adjusted return. What often gets lost is the multiple purposes it serves investors.
This commentary will help shed some light on why the 60/40 isn’t dead—but will likely face more bumps in the road ahead.
60/40 Returns
The truth is, for the first time in a LONG TIME, the 60/40 portfolio is struggling. It is off to the worst start to a year since 1976 (I wasn’t even born until 1980—yikes!). As worrisome as this fact is, as with markets, you need to focus on the big picture.
According to a study by Vanguard, from 1926 to 2019, a 60% stock/40% bond portfolio earned an average annual return of 8.77%. Furthermore, this combination experienced an annual loss in only 22 out of 94 years (~23.5%), with the steepest annual decline being 27.58% in 1931!
Does this past performance dictate how the next 94 years will look? Of course not, but it helps give some perspective to the bigger picture.
As mentioned in a previous market commentary, we need to remember how accommodating central banks have been for much of the past 10 years. The days of near-zero interest rates and seemingly unlimited monetary policy are likely behind us, which means the next 10 years won’t be as easy.
Source: PortfolioSlab.
This change means the likelihood of near double-digit annual returns will be more difficult to achieve. The global economy is trying to fight off 40-year-high inflation by rapidly raising interest rates. This move will likely slow economic growth, creating volatility for both stock and bond markets in the interim. Investors need to adjust their expectations for this scenario.
This is where financial planning can be instrumental as an advisor can help illustrate the impact that different long-term return assumptions will have on your financial goals.
Risk
Risk reduction is one of the least talked about benefits with a 60/40 portfolio. While this year has been tough on stocks and bonds, it is rare historically to see both stocks and bonds decline in the same year.
Source: Vanguard.
The chart above helps illustrate that. A few stats that stand out include:
Over a six-month period, stocks and bonds have both yielded negative returns only 3.6% of the time.
Over a three- and five-year period, stocks and bonds have never both yielded negative returns.
Over a one-year period, a 60% stock/40% bond portfolio has yielded a negative return only 13.6% of the time.
Over a five-year period, a 60% stock/40% bond portfolio has yielded a negative return only .6% of the time.
There are always short-term outliers, one of which we are experiencing right now. The mistake investors tend to make is to extrapolate the past six months and assume it will continue for the next six. Investments hardly ever work that way!
Rebalancing
Another benefit comes from rebalancing. As we know, all investments are not created equal. In periods where bonds significantly outperform stocks (e.g., 2008), a 60/40 would have shifted closer to 50/50 as stocks declined significantly and bond values increased.
By rebalancing, you would sell 10% from bonds and add 10% to stocks to get you back to your 60/40 baseline. Stocks went on a magical run in the years following 2008, and your portfolio would have benefited tremendously by rebalancing during this downturn.
The same holds when stocks significantly outperform bonds (e.g., 2017). In this scenario, you would sell profits from stocks and buy more bonds to get back to the 60/40 baseline. This move would have helped shield some volatility as stocks declined in 2018.
The key is making sure that your portfolio allocation doesn’t stray too far from your model allocation. This may help save you from selling during periods of extreme volatility, as so many investors fall prey to.
Does this mean you should use only stocks and bonds in building a portfolio? No, there are times when investments other than stocks and bonds can play a role, but their inclusion depends upon your specific situation. One thing is clear, though: The 60/40 is not dead and never has been. We just need to adjust our expectations and expect more volatility ahead.
In the end, investing involves a multitude of variables, many of which are out of our control. Focus on what you can control, and the rest will take care of itself.
Discuss your situation with a fee-only financial advisor.
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