The 60/40 portfolio recently passed its first real test since the 2022 bond market rout, according to Morningstar. During the stock market sell-off in the first week of August, high-quality bonds did what they are supposed to do — play defense, said Jason Kephart, director of multi-asset ratings at Morningstar. The Morningstar U.
S. Market Index, a yardstick for stocks, dropped 6.3% from Aug.
1 through Aug. 5, its worst five-day performance since June 2022. Meanwhile, the Morningstar U.
S. Core Bond Index rose 1.5% as investors fled to safety.
"Inflation wasn't the reason we were seeing this big stock market sell-off," Kephart explained. "When inflation is not the problem, we are seeing bonds perform as they used to." "It was beautiful," he added.
The strategy revolves around a simple balanced portfolio in which 60% gets allocated to stocks and 40% to fixed income. Traditionally, stocks and bonds move in opposite directions, which helps lower the volatility of the portfolio. However in 2022, both stocks and bonds nosedived when the Federal Reserve started hiking interest rates to fight inflation.
The iShares Core Growth Allocation ETF (AOR) that mimics the 60/40 portfolio sank 17.4% that year. AOR 1Y mountain The iShares Core Growth Allocation ETF mimics the 60/40 portfolio Since then, the strategy has been making a comeback.
The 60/40 portfolio has posted a 20.5% cumulative return since 2022 as of May 2024, according to Vanguard. Even with the 2022 rout, it has a 6.
2% annual return over the past decade, although that was mostly driven by the outperformance of equities, said Zachary Rayfield, head of goals-based investing research at Vanguard. The Valley Forge, Pennsylbania-based money firm now sees a strong decade ahead for a plain vanilla 60/40 strategy. "We don't expect the same level of outperformance on the equity side, but we expect the bond allocation to play a stronger role, not only in terms of being in a cushion and downside protection, but in terms of the overall portfolio performance," Rayfield said.
What might derail the performance is inflation-induced volatility, said Morningstar's Kephart. Interest rates typically go up when inflation is higher than expected, which causes bond prices to fall, sending bond yields higher. Stocks usually react negatively to higher borrowing costs.
That said, inflation today is cooling. The consumer price index, which measures the price of goods and services, rose 0.2% in July, less than economists had expected.
That put the 12-month inflation rate at 2.9%. "If inflation continues its current trajectory, you can count on bonds to be that reliable defense again," Kephart said.
Building a 60/40 portfolio The 60/40 is really another word for a balanced, diversified portfolio, so allocations can shift depending on your age and retirement date, as well as individual needs. Still, it's a great starting point, said Vanguard's Rayfield. "The 60/40 strikes that nice balance," he said.
"[It] allows [you] to be flexible to a variety of not just market scenarios, but goal timing scenarios." Within those buckets, investors should be diversified, said certified financial planner Marguerita Cheng, CEO of Blue Ocean Global Wealth. For equities, she likes to include a range of market capitalizations, from mega-cap stocks to small-caps.
In addition to U.S. stocks, she also includes international and sometimes emerging markets, depending on the age and risk tolerance of the client.
She also has a mix of growth and value stocks, since they have different cycles. When it comes to fixed income, she also wants diversification in terms of maturity and credit. For wealthy clients, Cheng likes to include municipal bonds since they are free of federal tax, as well as state and local taxes if an investor lives in the same jursidiction as the issuer.
She doesn't look for funds that use leverage or take on too much risk. "If you are not sure what you should be including, you can look for something that has the name total return or strategic income," Cheng advised. For Morningstar's Kephart, high-quality bonds are a pretty safe bet right now.
Funds that track the Bloomberg Aggregate Bond Index are a good place to look, he said. However, high-yield bonds — also known as junk bonds — have not historically been the best diversifier, he noted. He would also stay away from more complicated investments, like liquid alternative funds.
"The 60/40, when people talk about, 'It is broken' or 'It is dead,' really they are trying to sell you something more complex and more expensive," Kephart said, noting those complex investments don't typically lead to better outcomes. "If you want to keep it simple, invest in the S & P and Bloomberg Agg. You are going to have a pretty solid portfolio," he added.
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