Is the 60/40 portfolio dead?
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The 60/40 portfolio (a portfolio invested 60% in equities and 40% in fixed income) has long been used by moderate-risk investors. The equity sleeve could provide long-term growth, while the fixed income sleeve could dampen volatility and smooth the ride for investors. But after a very rough 2022, some are questioning the ongoing viability of the strategy.
Historically Solid
Over the long haul, the strategy has been quite effective. For the 96 years between 1926 and Dec. 31, 2021, the annualized return was 8.8% (source: Vanguard). That’s a very attractive return for a moderately risky portfolio.
But Not Foolproof
Even though a strategy works over the long haul, it still needs to be successful over the short term. 2022 was a brutal year for this strategy. While the stock market’s decline was unpleasant (the S&P 500 was down 18.1%), it was not all that unusual. Stock market declines like that happen on average every 8-10 years. However, the broad bond index was down over 13% – the worst performance ever for U.S. bonds. The historical pattern of investors flocking to bonds during a stock market downturn did not happen. This was largely due to the Federal Reserve’s aggressive rate hikes as they sought to tamp down rampant inflation. In short, it was a year where there was no place to hide – unless you happened to be sitting in cash all year!
The strategy can also provide underwhelming results over longer periods. The 2000’s, for example, saw a very modest 2.3% annual return for the strategy. The internet bubble burst early in the decade, and the sell-off from the Great Financial Crisis led to a slightly negative return for the stock market over those ten years. Bonds did provide a positive return, but they could not drive high returns by themselves.
Is the Strategy Broken?
In short, I don’t think so. The strategy has had bad years and even bad decades, but I have yet to see an investment strategy that does not. I don’t believe Bernie Madoff ever had a down year, but that did not end well.
As noted earlier, the stock market will have its ups and downs. But it is still your best bet for inflation-beating returns over the long term. Warren Buffett always likes to say that an investment in the stock market is a bet on America. We certainly have our issues, but I am not yet ready to bet against us.
As for bonds, one important aspect to consider is that the horrible results in 2022 (and, to a lesser degree, in 2023) have set bondholders up for better days ahead. Five and 10-year Treasuries now pay around 4.5%, much higher than you could get a few years ago. Other types of bonds offer even higher yields, though they carry additional risks. There is also the possibility that the Fed will start cutting rates in the not-too-distant future. That could provide a nice tailwind to bond returns.
Summary
It is always tempting to make changes after disappointing outcomes, but this is often the wrong move in investing. Keep your focus on your long term goals, investment objectives and your risk tolerance versus overreacting to short-term moves no matter how unpleasant.
David Crossman, CFA, is a Senior Portfolio Manager with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email David at dcrossman@bedelfinancial.com.