With inflation and the dramatic Federal Reserve rate hikes of 2022, many proclaimed the 60/40 portfolio deader than Caesar’s ghost. However, as inflation cools and rate hikes slow, more fund managers and investors have come to praise the concept – not bury it.
Balancing an investment portfolio with 60 percent stocks and 40 per bonds has long been the set-it-and-forget-it strategy for managing money. By balancing investments that way, managers hoped to generate a solid return with minimal risk.
The way it works is that stocks offer the potential for growth and higher returns. However, they can be volatile. Bonds, on the other hand, tend to produce steady yields with less risk. Indeed, the 60/40 portfolio has been successful for over five decades.
2022
However, 2022 happened. Last year, inflation kept popping up like Whack-a-Mole and the Fed hammered it with repeated rate hikes.
Those rate increases drove bond yields down. At the same time, the uncertain economic outlook produced volatility in equities markets. As a result, the first three quarters of last year were the worst in history for the 60/40 portfolio.
Nevertheless, looking a little farther back shows that the strategy has held up. For the 10 years through the end of 2022, the 60/40 portfolio produced a 6.1 percent return, according to Vanguard.
“The past decade has been a strong run for the 60/40,” said Todd Schlanger, a senior investment strategist at Vanguard. “If you look at the nine years prior to 2022, a globally diversified portfolio posted a lofty 8.9% annualized return, despite the low-interest rate environment.”
Improved Outlook for 60/40 Portfolio
Last year may have been the bottom for the 60/40 portfolio. However, it produced a benefit for the strategy going forward.
Schlanger notes that the valuation of equities has fallen more in line with reality.
“While 2022 may have been painful for investors, the result was that valuations for asset classes are now lower, and most are fairly valued,” said Schlanger. “The notable exception: U.S. stocks, which are more reasonably priced now but still above what we consider to be the fair-value range.”
A report this week from LPL Research backs up Vanguard’s assessment.
The LPL report notes the unexpected downturn in bonds last year. However, it states that “the tide does seem to be turning. While the fourth quarter of 2022 and the first quarter of 2023 weren’t spectacular for the 60/40, using the total return for the S&P 500 Index and the Bloomberg U.S. Aggregate Bond Index as our proxy for stocks and bonds, the 60/40 has been on solid footing the last two quarters …”
The Long View
As noted, 2022 was not a normal year for the 60/40 portfolio. However, most money managers feel it was an anomaly. As a result, investors who abandoned ship could find themselves in treacherous waters.
“We saw a lot of folks exit balanced strategies in 2022,” said Hilda Applbaum, an equity portfolio manager for Capital Group’s American Balanced Fund. “While there is a lot of wisdom in markets, there also is a herd mentality. I believe many investors have become disbelievers in balanced strategies at the wrong time. I am confident that, going forward, balanced portfolios — whether they are a 60/40 split or 65/35 — may continue to be a successful approach for most investors over the long term.”
Part of the bright future for the 60/40 portfolio is improving bond rates. As inflation subsides and Fed rate hikes ease, Applebaum and Schlanger see bonds returning to their role as income producers and stabilizers.
“Last year many types of asset allocation models failed to deliver on their pursuit of solid returns with moderate risk,” said Applbaum. “But that followed a long period of relative success. Asset allocation is not a broken or failed strategy. It will always make sense to think about balance, diversification, and risk in portfolios. But a one-size-fits-all approach doesn’t work. It’s about building portfolios from the bottom up that align with investor objectives.”
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