- A 60/40 portfolio of stocks and bonds has long been the gold standard for navigating the market’s ups and downs.
- You shouldn’t necessarily take a set-it-and-forget-it approach, though, as it’s possible that a 60/40 portfolio may not always offset losses.
- Investing in commodities like gold and foreign assets may be a good way to further diversify.
- Certain types of funds can also provide more flexibility to reap gains in an economic downturn.
A portfolio allocated 60 percent to stocks and 40 percent to high-quality bonds is the investing equivalent of chocolate and vanilla ice cream: maybe not the most exciting choice, but an easy one to make if you don’t want to give it too much thought. You know it’s hard to go wrong with it and you’ll probably like it well enough.
The logic of the 60/40 portfolio, and the reason it has become a staple of financial planning—it’s the benchmark against which other balanced portfolios are often measured—is clear and easy to understand.
When economic growth is strong, corporate earnings growth tends to rise, but so do interest rates. That’s typically good for stocks and bad for bonds.
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When economic growth slows, so does earnings growth, depressing stock prices, and if a recession occurs, earnings may fall or even turn negative, depressing stock prices even more. Interest rates are inclined to fall amid such a backdrop, however, supporting bonds.
Put it all together and a 60/40 portfolio should smooth out returns across an economic cycle, producing strong performance relative to risk. It works in theory, and for the last decade or two it has worked in practice.
A 60/40 portfolio returned 18 percent a year in the three years through 2021, according to Bloomberg News, and a less stellar but still excellent 11.1 percent a year in the 10 years through last October, as Goldman Sachs Asset Management figures it.[1,2]
This year has been a different story, though. SPDR S&P 500, an exchange-traded fund that tracks the performance of the S&P 500 index, the most widely followed stock index on Wall Street, fell 20.6 percent this year through June 15. The iShares Core U.S. Aggregate Bond ETF, a large fund that holds Treasury bonds and other investment-grade issues, suffered an 11.6 percent decline over the same period.
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The problem is that while rising interest rates can provide a benign backdrop for stocks because it tends to coincide with stronger economic growth, this time around the economy appears to be slowing. Also, the rise in rates needs to be modest. It remains to be seen how high rates will go, but the highest inflation rate in 40 years, reported earlier this month, suggests the peak in rates has not yet come and gone.
After such dismal results this year, and with the outlook iffy at best, should you stick with 60/40, essentially betting on a return to form? Should you abandon it altogether? Or should you tweak the mix a bit, adding gold or other commodities or some other version of strawberry?
Doug Loeffler, executive vice president of investment management at Sierra Investments, thinks 60/40 is a fine idea, just not right now.
“I don’t think the concept is necessarily wrong or bad,” he said. “But it may not work as long as we remain in a period of high inflation.”
Loeffler encourages investors to diversify further by putting a portion of the stock side of the portfolio into foreign markets and/or commodities, which are solid inflation hedges.
Another option Loeffler mentioned is to invest in market-neutral funds, which hold certain stocks that the managers expect to do particularly well, while selling others short, which is a way to benefit if their prices fall. Yet another possibility is so-called hedged-equity funds, in which the managers use various complex financial instruments and techniques to limit losses, although this also may result in gains being capped.
Victoria Greene, chief investment officer at G Squared Private Wealth, is also a fan of market-neutral funds and other alternative investments, such as long-short equity funds. These follow the same basic idea as market-neutral funds, but while the latter aim to have no net exposure to the stock market’s direction, long-short funds can bet on the broad market going up or down to different degrees.
“This is their year to shine,” given the shakiness of conventional stocks and bonds, Greene said of alt funds generally.
While 60/40 portfolios certainly haven’t been shining this year, she doesn’t consider their reputation tarnished, either.
“I’m not in the camp that the death of 60/40 is coming,” Greene said. Even so, she added, “one thing investors need to realize is that it matters what’s in the 60 and what’s in the 40.”
Bond portfolios became too exposed to rising rates after a decade in which the Federal Reserve kept rates artificially low to support economic growth, in her view. She thinks their exposure is still too high, so she would concentrate on bonds with short maturities, say two years, and she also likes municipal issues. As for stocks, Greene favors the energy sector and high-quality companies that pay healthy dividends, whatever business the dividend payers are in.
Some investors may be tempted to stick with their 60/40 asset allocation in the reasonable understanding that market trends tend to revert to the mean—to reverse course after reaching extremes and head back in the direction they came from. The problem is that’s what seems to be happening now. The sharp declines in stocks and bonds may be the reversion to the mean after many years in which both mainstream asset classes offered strong performance, boosted artificially by lax Fed policy. But by conventional historical standards, stocks and bonds remain quite expensive. Whether or not you want to try some other flavors of investment —commodities, alts, whatever—it could be a while before vanilla and chocolate become palatable again.