Historically, long-term investors have found diversity and resilience through the use of the conventional 60/40 portfolio structure.
The majority of financial advisors and stockbrokers built their customers' portfolios with 60% shares and 40% bonds or other fixed-income securities.
Throughout the 1980s and 1990s, these so-called balanced portfolios performed rather well. A 60/40 portfolio of U.S. stocks and bonds have generated a remarkable 11.5% average yearly return since the financial crisis.
However, a string of bear markets that began in 2000 and historically low-interest rates have diminished the appeal of this fundamental investment strategy. According to some experts, a well-diversified portfolio should now contain more asset types than just equities and bonds.
These experts believe that to achieve sustainable long-term growth, a far broader strategy must now be taken, as we'll see below.
In this article we explore what the 60/40 portfolio strategy is, and if it is still viable as an investment strategy at this current time.
The 60/40 portfolio is a strategy of the modern portfolio theory developed by Nobel Laureate Harry Markowitz in 1952.
This portfolio plan consists of 60% equities and 40% bonds portfolio structure. Due to its consistent returns and low-risk approach, this portfolio strategy became the standard practice in portfolio management among individual and institutional investors.
When it was initially established, the 60/40 portfolio was successful for various reasons
The Federal Reserve was able to contain the excessive inflation of the previous decade in the early 1980s, which resulted in declining Treasury rates and decreased correlations between stocks and bonds.
This contributed to both asset classes' appealing diversity and strong overall returns.
Treasury yields are inversely correlated with asset values.
Stocks and bonds generally tended to gain as inflation-adjusted, or "real," rates progressively declined during the last four decades as businesses benefited from decreased capital costs and greater values for financial assets.
Investors became more assured that they could rely on a "Fed put"— a central bank intervention intended to provide liquidity in the financial system and control market volatility. Markets became ever more convinced that the Fed would always bail them out during periods of economic uncertainty.
However, the current economic situation has gotten financial analysts to question if the 60/40 portfolio strategy is still viable.
Investors are grappling with surging inflation, rising interest rates, and turbulent geopolitics. As the likelihood of recession increases, asset owners such as these are facing significant uncertainties.
The near-term environment for stocks and bonds could continue to be challenging with the Fed aggressively raising rates to tame inflation.
Bonds have struggled while rates have risen, while investor concerns are shifting to slowing economic growth. Also, stocks could continue to face additional headwinds as earnings expectations are revised down
Given this, it may be difficult for the 60/40 portfolio strategy to be effective in such a gloomy economic scenario.
The only way to know if the 60/40 portfolio structure is irrelevant is to look at the numbers.
According to data, an investor who was invested in stocks for one year had an 18.2% chance of losing money.
Over three years, the odds reduce to 13.4%, while in five years, the chances of losing money fell to 9.6% and further down to 4.7% in 10 years. By the 15th year, the investor odds are they wouldn't lose money on stocks.
Compare that with the four-decade returns using the 60/40 portfolio. In 42 years, from 1980 to 2022, investors that structured their portfolios with this formula had positive returns in 35 years.
That means investors who relied on this investment mix have seen their portfolios increase in value 83% of the time. This shows that by a far margin, the 60/40 portfolio mix is still very much efficient.
If you are still unsure if the 60/40 portfolio mix can deliver the same returns, rather than taking a more risky approach to replicate its results, there are some strategies you can give a thought to. Let's have a look at them.
By employing techniques like tax-loss harvesting or using realized losses to partially offset capital gains for tax purposes, you might try to boost after-tax returns.
Many investors favor either passive techniques, which follow an index or active strategies, which try to exceed the index, although the two are not exclusive. Over time, it may be advantageous to combine them in a portfolio and modify allocations in response to shifting market conditions.
Investors may profit from selecting top-notch asset managers across a variety of asset classes and market conditions. This could potentially enhance risk-adjusted returns in your portfolio.
Some forms of hedged alternative investments can offer diversification, which also may improve portfolio returns.
In some situations, the 60/40 stock/bond combination has produced greater returns, but it also has significant drawbacks.
A rising number of scholars and money managers are advising a broader asset allocation to achieve long-term gain with a manageable amount of risk as a result of the market instability of recent years.
Investment is a long-term commitment. When compared to the 40+ years of returns, one or two bad years are an inconvenience any long-term investor should be able to take. The best advice for investors is to focus not on where returns have been, but on where they could be in the months and years ahead.
The 60/40 portfolio mix may require some extra patience to achieve your financial goals. But the consequences of taking on excessive risk could jeopardize your investment goal totally, thus leaving you to pay a hefty long-term penalty for a short-term gain.
