The classic 60/40 investment strategy involves allocating 60% of your capital towards stocks and 40% in bonds. This classic portfolio mix is designed to help investors benefit from the stock market’s long-term capital appreciation, while smoothing out some of the volatile market fluctuations and with fixed income instruments.
The idea is that equities and fixed income usually don’t move in tandem, therefore when stocks perform poorly, bonds should be able to provide diversification and cushion through income.
Why is the 60/40 portfolio a classic allocation?
To understand why this strategy has been an investment mainstay for decades, let’s compare the 60/40 portfolio’s returns with two extremes, (1) a 100% stocks portfolio and (2) a 100% bonds portfolio from 1926 to 2021.
Based on calculations by Vanguard — the historical average annual return for a 100% stock portfolio from 1926-2021 was 12.3%, with its worst year (1931) returning -43.1%, while the 100% bond portfolio posted an average annual return of 6.3%, and its worst performance (1969) was -8.1%.
For the 60/40 portfolio, the average annual return came in at 9.9%, with its worst year (1931) returning -26.6%.
This shows that through 1926-2021, the 60/40 portfolio has offered solid returns at reduced levels of volatility. For the moderate-risk investor with a mid to long-term investment horizon, it presents an optimal risk-reward profile.
Why has it been debated recently - is the 60/40 “dead”?
To be clear, the 60/40 classic portfolio has taken a hit in the last few years, with some questioning its effectiveness, especially since the onset of Covid-19.
At the height of the Covid-19 pandemic in 2020, the high valuations of equities coupled with the low interest-rate environment diminished the appeal of the 60/40 portfolio.
Governments around the world had slashed interest rates to cushion some of the pandemic’s shock to the economies. As a result, the returns on existing government bonds became limited or non-existent. On the other hand, massive government stimulus, especially in the US, buoyed stock markets, with equities starting their climb in March 2020 and reaching all-time highs by late 2021.
Given those conditions, it was not surprising for the average investor to be tempted to ditch the 60/40 allocation then. Some sought out growth opportunities in equities, particularly with high-flying tech stocks, while cutting their exposure to bonds.
Going into 2022, the classic 60/40 mix saw further stress. Stubbornly high inflation led to rate hikes by the US Federal Reserve at unprecedented fast, which caused turbulence and uncertainty across most asset classes.
That disrupted the traditional relationship between stocks and bonds. Both asset classes moved in the same direction and suffered – downwards, with both equities and fixed income recording double digit losses for the year. The combination of falling equity and bond prices has unsurprisingly led to losses in 60/40 portfolios.
Why the 60/40 portfolio remains relevant
Although the 60/40 portfolio suffered a setback in 2022, it doesn’t mean we should throw the entire strategy out the window.
This long-proven strategy remains relevant and still has value for investors, given its long-term durability and benefits of risk reduction.
For one, the simultaneous declines in both stocks and bonds in 2022 was very much a rare event. Based on analysis by Blackrock, looking back at a 93 year span, from 1929-2022, there were only 4 instances this has happened.
Looking at the chart and referencing back to the law of averages also suggests that periods of negative returns should be followed by years of higher-than-average returns. And indeed, with the painful market adjustments in 2022, valuations across all asset classes look more favourable. Expected fixed income returns in the coming years also look to be much higher than what we saw in the past decade. These are reasons why the US fund giant, Vanguard has recently upgraded its annualised 10-year median returns outlook for the 60/40 portfolio in March 2023, and declared the classic strategy is “far from dead”, but poised for strong growth in the coming decade.
Tweaks to enhance the classic 60/40 portfolio
Investors may wish to continue following the 60/40 approach, but that does not prevent you from considering tweaks to further enhance resilience of this classic investment strategy.
For example, one option is to make each of the stock and bond categories more diversified — be it in developed markets versus emerging markets, large-cap stocks versus small-cap stocks, or investment-grade bonds versus high-yield bonds – while keeping to the overall 60% and 40% allocation.
Some investors may also want to tilt the fixed-income portion of the portfolio towards inflation-protected securities or floating-rate debt instruments to hedge against inflation.
Professional Investors may also consider adding exposure to alternative investments such as hedge funds, private equity and credit, that can add further diversification, target new sources of return and further strengthen the resilience of your total portfolio.
The power of long-term investing and compounding
We agree these are turbulent times for investors, with rising interest rates, stubbornly high inflation, recession fears, and geopolitical tensions continuing to impact market sentiments around the world.
But boom and bust cycles have long been a feature of investing. Resist the urge to sell or ditch your investment strategy such as your 60/40 portfolio. Staying the course during big declines can help you reap the long-term benefits of compounding.
Data shows that those who stick with an investment plan at a risk level suitable for their goals — while remaining diversified in their asset allocation, and at a low cost — stand a much better chance of success than others who try to speculate and time their exposure to markets, geographies, and sectors.
You can get started with your 60/40 portfolio on Endowus Fund Smart yourself or using our Endowus Model Portfolios. To start your journey with Endowus, click here.
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