Building a classic 60/40 portfolio
Endowus Insights

Building a classic 60/40 portfolio

Updated
6
Sep 2022
published
8
Aug 2022
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portfolio-construction-asset-allocation

The classic 60/40 investment strategy involves allocating 60% of your capital towards stocks and 40% in bonds. This traditional portfolio mix carries a moderate level of risk.  

It allows investors to benefit from the stock market’s long-term capital appreciation, while smoothing out some of the volatile market fluctuations and with low-risk government bonds.

The idea is that equities and fixed income usually don’t move in tandem, therefore when stocks perform poorly, bonds may offset some of the losses and provide income.

Why is the 60/40 portfolio a classic allocation?

To understand why the balanced 60/40 mix has been an investment mainstay for decades, let’s compare its returns with two extremes — a 100% stocks portfolio and a 100% bonds portfolio — from 1926 to 2021.

The historical average annual return for the all-stocks portfolio during that period was 12.3%, with its worst year (1931) returning -43%, based on calculations by Vanguard. The all-bonds portfolio posted an average annual return of 6.3%, and its worst performance (1969) was -8%.

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 the 60/40 portfolio has offered solid returns and lower levels of volatility. For the moderate-risk investor with a mid to long-term investment horizon, it presents the most optimal risk-reward profile.

Why has it been debated recently?

To be clear, the classic allocation model has taken a hit in the last couple of years.

For one thing, at the height of the Covid-19 crisis 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, the 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 or alternative assets such as real estate, while cutting their exposure to bonds.

But the classic 60/40 mix is seeing further stress in 2022. Stubbornly high inflation and rising interest rates are now causing turbulence and uncertainty across most asset classes.

That has also disrupted the traditional relationship between stocks and government bonds. Both asset classes have been moving in the same direction – downwards – in recent months. The combination of falling equity and bond prices has unsurprisingly led to losses in 60/40 portfolios.

Read more: Seven charts on why you should invest regularly when markets are down

Why a 60/40 portfolio will endure

That being said, just because the current market dynamics are not favourable for the 60/40 strategy, it doesn’t mean we should throw the entire strategy out the window.

Despite the present headwinds, the 60/40 portfolio remains relevant and still has value for investors, given its long-term durability and benefits of risk reduction. An analysis by US mutual fund company Northwestern Mutual found that out of all the rolling five-year periods from 1976 till today, only one 60/40 investor cohort suffered negative returns; this was the cohort that bought in 2004 and sold in 2009. All the other cohorts reaped positive returns.

A recent podcast by Morgan Stanley also noted that even if stocks and bonds are now positively correlated, that correlation is still well below 1 to 1. "That means there are still plenty of days where they don't move together, and this can matter significantly for how a portfolio behaves, and how diversification is delivered, over time," said Andrew Sheets, chief cross asset strategist for Morgan Stanley.

He also pointed out that the 60/40 portfolio is still beneficial in reducing volatility. Despite it being one of the worst declines for bond prices in the last 40 years, the trailing one-year volatility of the US aggregate bond index is still just about 6% — one third the volatility of US stocks over the same period.

Investors may wish to continue following the 60/40 approach, but with some tweaks to better ensure long-term growth.

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.

In the current decade, investors should prepare for greater market volatility and get used to a lower-return environment, including from a diversified portfolio of stocks and bonds.

At the end of the day, your financial goals, investment time horizon, risk appetite, and size of capital should go into determining your strategic asset allocation. 

The 60/40 portfolio often hits the sweet spot in terms of balancing diversification, growth, and risk mitigation for long-term investors. That is why it remains a hard benchmark to beat and can stand the test of time to outlast its naysayers. 

To get started on a portfolio with Endowus, click here.

Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: What is a core-satellite investment strategy?

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Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund. 

Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.

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