60/40 portfolio

The 60/40 portfolio, a mix of 60% stocks or equities and 40% bonds or other fixed-income offerings, has been popular throughout the past several decades. It was developed in the 1960s and grew in popularity much in part due to more stabilized annual returns than only investing into equities. However after a series of bear markets and extremely low interest rates in the late 2010s and early 2020s, that approach to asset allocation appears to be broken. Why is that and what can you do about it?

When you look at the idea behind the 60/40 portfolio, it was meant to offer diversification. You had a mix of stocks/equities that could potentially offer more upside potential, but with it comes more downside risk, and you then added a mix of traditional U.S. bonds that offered a more stable investment vehicle. In theory, bonds and stocks often had an inverse relationship; when stocks were up, bonds would be down, and vice versa. In most of these types of portfolios, the bonds tend to be U.S. bonds in either U.S. corporations or the U.S. treasury. And the stocks tend to be primarily mutual funds or portfolios of individual stocks. 

While this may be thought of as a good starting point for investing, it doesn’t offer the type of true diversification you may think. Diversification means that you have a whole lot of stuff in your portfolio that just doesn’t move up and down together. Diversification means that if one thing in the portfolio zigs, another one zags. You essentially have different investments hedging other investments. 

When the traditional 60/40 blend was created, bond yields were fruitful, and the stock market was in the midst of a long secular bull market. The problem with always expecting a higher return form stocks is the potential of lackluster performance over shorter periods of time, especially when we consider the big loss potential illustrated by the 49% decline from 2000-2002 on the S&P500 and a staggering 56.8% in the Great Recession back in 2007-2009. In recent years, the traditional 60/40 diversification of stocks and bonds has not worked where they helped balance each other when one was down.

Many economists believe that in the future the true real return of a 60/40 stock bond portfolio will only beat inflation by 1.4-2.9% over time. Additionally, because people are living longer, the risk of running out of money is a real concern.

In today’s world, we believe in a much greater level of diversification. Portfolios need additional holdings that zig and zag, things like natural resources, commodities, energy, real estate, or non-traditional bonds. When you are in your 30s, taking a lot of risk and maximizing long-term growth a predominantly stock-based portfolio might be okay. But as you get older and need more stability in your investment mix, that extra diversification often becomes more and more important.