Diversification is the basis of long-term investing. By spreading your dollars across a mix of asset classes, sectors and industries, you help reduce the risk of significant portfolio losses in any given year.
And for decades, the 60/40 rule has been a cornerstone of diversification. A 60/40 investing strategy allocates 60 percent of holdings to stocks – a high-risk, high-reward asset – and 40 percent to bonds – long considered boring but reliable. The idea is that one balances the other, creating more stability than a stock-heavy portfolio and better returns than a bond-heavy portfolio.
The 60/40 mix has been described as “dead” and “alive and well” many times since the concept was developed by Nobel Prize winner Harry Markowitz in 1952.
While many analysts and experts predicted the demise of the 60/40 rule at the end of 2023 – a particularly brutal year for both stocks and bonds – this long-term investment strategy looks positive again in 2024 and beyond.
What is the 60/40 rule?
The 60/40 portfolio is a simple investment strategy in which 60 percent of your assets are invested in shares and 40 percent in bonds. It is also called a ‘balanced portfolio’.
The 60/40 rule has been widely recognized and recommended by financial advisors and experts for decades. The idea is that stocks have historically delivered higher returns over the long term, while bonds offer fixed income and can act as a cushion during market downturns.
While the 60/40 split is a starting point, experts agree that the default allocation should be tailored to an investor’s risk tolerance, time horizon, and goals. For example, a younger investor with a higher risk tolerance may take a more aggressive 80/20 approach, while a recent retiree may prefer a 40/60 approach.
Criticism of the 60/40 rule will grow in 2023
Both stocks and bonds tumbled in 2023. High inflation, rising interest rates and worries about a looming recession caused the benchmark S&P 500 index to fall 18 percent. The Total Bond Index, which tracks U.S. investment-grade bonds, lost more than 13 percent.
If you had held a 60/40 mix of stocks and bonds in 2023, you would have lost 16 percent, according to Vanguard calculations. Neither stocks nor bonds could soften the blow to investors’ earnings.
Many analysts and strategists criticized or were at least skeptical about the 60/40 portfolio, which failed to protect investors from a historically volatile year. Data from JP Morgan Chase shows that 2023 was one of the worst years for a 60/40 portfolio since the mid-1970s.
“We think investors have many reasons to worry that the 60/40 could be dead,” said a letter from Goldman Sachs in January 2023. Meanwhile, publications like Barron’s and Kiplinger wrote headlines literally titled “The 60/ 40 portfolio is dead.”
Is the 60/40 rule back?
Despite the pessimism, stocks and bonds recovered spectacularly as 2023 came to a close.
Stocks rose in November and December, fueled in part by news from the Fed about expected rate cuts in 2024. In 2023, the S&P 500 rose 24 percent and the NASDAQ 100 posted a stunning 55 percent gain — the tech heavy’s best annual performance index. since 1999.
Another reason for the renewed optimism: Higher bond yields today portend more attractive future returns, especially if prevailing interest rates cool from their 2023 peak.
“With rates higher today, coupled with declining inflation and a Fed likely to cut rates this year, bonds should continue to provide support when added to an equity portfolio,” said Collin Martin, fixed income strategist at the Schwab Center for Financial Research. .
Factors that led to the 2023 drop in bond prices — record low bond yields and the start of the Fed’s most aggressive series of rate hikes in decades — no longer exist.
“We believe 2023 was the anomaly,” says Martin. “Today, bond yields remain near their highest levels since the global financial crisis, meaning there is much more income to be earned that could help offset potential price declines should they occur.”
Vanguard, the world’s second-largest asset manager, raised its return expectations for US bonds for the next ten years to a nominal annualized range of 4.8 – 5.8 percent. Compare that to the 1.5 to 2.5 percent she expected before the Fed started raising rates in March 2023.
In his economic and market outlook for 2024Vanguard expects interest rates to remain above the inflation rate for years to come, providing a stable foundation for long-term risk-adjusted returns.
That means good news for well-diversified investors and followers of the 60/40 rule. In fact, according to a report from Bank of America Global Research, November 2023 was the best month for traditional stock and bond allocation since 1991. Similarly, a portfolio with a 60 percent weighting in the Morningstar US Market Index and a weighting of 40 percent in the Morningstar US Core Bond Index, a return of 18 percent in 2023.
Will stocks avoid the 60/40 rule?
However, the renewed appreciation for the 60/40 portfolio could soon disappear again. The outlook for bonds is bright, but the outlook for equities has fallen after 2023’s red-hot year-end rally.
The average expected nominal return for U.S. stocks over the next decade is just 5.5 percent, compared to the average of 11.6 percent over the past decade, according to forecasts from seven major asset managers analyzed by Moringstar.
“It appears the 60/40 portfolio has returned, but how long it will last is another story,” says Lawrence Sprung, a certified financial planner and founder of Mitlin Financial. “It will be interesting to see how that develops over the course of the year.”
At its core, the 60/40 portfolio is for playing the long game. It’s not supposed to be tweaked and adjusted every time the market takes a nosedive. While it is easy to criticize traditional balanced portfolios for not adapting to market changes, creating a more effective strategy is a challenge. The best way to respond to market shifts, especially fundamental changes, usually only becomes clear in retrospect.
In short
Despite its imperfections, the 60/40 rule remains a solid starting point for portfolio construction, thanks to its simplicity and proven long-term resilience.
“Investors often get into trouble simply by making changes based on current events,” says Sprung. “The 60/40 rule is good for providing structure and discipline to an investor’s portfolio.”
So you could say the 60/40 rule is back, although proponents argue it never really went away.
