Britannica Money (2024)

One of the first things you learn as a new investor is to seek the best portfolio mix. Many financial advisors recommend a 60/40 asset allocation between stocks and fixed income to take advantage of growth while keeping up your defenses.

Here’s how 60/40 is supposed to work:

• In a good year on Wall Street, the 60% of your portfolio in stocks provides strong growth.
• In a down year, having 40% of your portfolio in fixed-income assets like bonds protects at least some of your stash from Wall Street’s worst losses, because bonds usually, but not always, do better than stocks in tough times.

Like a lot of things, that began to change during and after the COVID-19 pandemic, and now 60/40 seems in danger of fading with the “before times.” The big blow came in 2022, when stocks and bonds both got crushed during the first three-quarters of the year.

“It is no secret that 2022 has not exactly been the year of the 60/40 portfolio,” wealth management firm Bespoke Investment Group noted in an August 2022 report to investors. “This year has left nothing safe, with both stocks and bonds hit hard. … No matter which way you cut it, 2022 has been the worst year of the past half century for stocks and bonds combined.”

Stocks dove in 2022 amid inflation, supply-chain issues, COVID-19-related shutdowns in China, the Russian attack on Ukraine, and worries about falling U.S. corporate earnings. Meanwhile, bonds offered no protection, falling sharply as the Federal Reserve fought inflation with dramatic increases in interest rates (bonds fall as rates rise).

Asset allocation is still important

If 60/40 is dead, how do you plan your asset allocation? Is 70/30 the new 60/40? Or something else?

First, don’t be too quick to abandon 60/40:

• 2022 is an outlier, not necessarily the new normal. The only other years that saw both bonds and stocks sitting on losses through August were 1973, 1974, and 1981, Bespoke said in its report. This applied to both corporate and government bonds.
• Goldman Sachs noted in a 2021 report, “The classic 60/40 portfolio has generated an impressive 11.1% annual return over the last decade.”
• The Fed’s rate increases mean you can get better yields on bonds purchased at lower prices.

That doesn’t mean 60/40 was always a great idea. During a so-called “lost decade” starting in the early 2000s, a 60/40 portfolio gained just 2.3% a year on average, Goldman noted.

Until the Fed began aggressively raising rates in 2022, interest rates were historically low, meaning fixed income assets didn’t pay the impressive yields investors enjoyed decades ago. Plus, heading into the pandemic, stocks were relatively expensive, as measured by the S&P 500 forward price-to-earnings (P/E) ratio, which was above 18 in the early 2020s as opposed to a historic P/E closer to 15 or 16. Employing a 60/40 investing strategy during times of lofty P/E ratios means buying stocks at higher than normal prices, possibly with less future growth.

But generally, 60/40, 70/30, and other asset allocation strategies continue to make sense. The idea is to benefit when stocks bounce and get some protection when markets fall or stagnate. But you might want to tinker with your portfolio as the tide goes in and out, rather than setting the dial at 60/40 and never looking again.

Adjusting for age and exploring alternatives

Some investment experts recommend adjusting your asset allocation over time. For instance:

• In your 20s and 30s, when you have many years left to work, you might go with a more aggressive stocks/bonds formula like 80/20 or 70/30. The idea is that you should have plenty of time to recoup any major losses, because retirement is far away (and you have a salary to live on). Also, early growth (hopefully) in the stock side of your portfolio allows you to take better advantage of compounding.
• In your 40s and 50s, you might get a bit less aggressive and adjust to a 55/45 or even 50/50 asset allocation. This protects you somewhat from the danger of starting retirement with huge recent losses in the case of a poorly timed bear market.
• In retirement, you still need some growth, but you might rely more on income as you try to protect your money. In that case, even a 40/60 allocation of stocks to bonds might make sense.

You can also tinker with the formula and consider a 55/35/10 or 50/40/10 strategy where you pepper in some alternative investments. This might mean exploring real estate investment trusts (REITS), commodities, gold, cryptocurrencies, or other asset classes that don’t tend to move in lockstep with the stock market.

Although crypto and real estate seem closely linked to the fortunes of large-cap stocks, commodities (think oil, grains, and industrial metals) could offer growth when stock and bonds get buried. They did pretty well in 2022, helped by rising prices.

The bottom line

A 60/40 mix doesn’t have to be monolithic—many different types of stocks and bonds are available. If you want to stay 60/40 but get a bit more protection for the “60” bucket, you could direct some funds into “defensive” stock sectors like consumer staples or utilities, which can be less volatile than large-caps. These sectors also typically offer appetizing dividends, which you could consider keeping instead of reinvesting as your income needs grow in retirement, or if you dial back on work.

On the other hand, if you want the “40” bucket to generate higher returns, consider sprinkling in some corporate bonds instead of just government bonds. You could even try high-yield bonds, which often generate better income. This doesn’t mean risky purchases of individual bonds. Instead, you could find a high-yield mutual fund where the collapse of one component doesn’t puncture your portfolio.

References

• 2022 Slams Stocks and Bonds | bespokepremium.com
• Is the 60/40 Dead? | gsam.com