Despite recent challenges, the 60/40 portfolio isn’t broken
- The 60/40 portfolio (a portfolio allocated to 60% stocks and 40% bonds) has been a long-standing pillar of strategic asset allocation, exhibiting the benefits of diversification. The success of the 60/40 portfolio through the history of modern finance had garnered much acclaim as both stocks and bonds contributed to strong returns.
- The nature of the recent market turmoil has put both stocks and bonds in negative territory, a rare occurrence in the historical context of their relationship. The resulting 60/40 portfolio’s negative return has some investors questioning the benefits of diversification.
- While the 2022 market selloff has hurt both stocks and bonds, with more potential volatility ahead, the longer-term correlation benefits of these major asset classes are still intact. Furthermore, the resulting higher yields have made bonds more attractive than they were at the end of 2021, boosting the expected return of the 60/40 portfolio and aligning it more with the historical experience.
Keeping it simple
Some leaders in their fields become such groundbreakers that they have wide recognition through just one name, such as Jordan, Brady, Spielberg, Buffett, and the 60/40. Built with the simple yet elegant concept of diversification, a portfolio consisting of 60% stocks and 40% bonds, has delivered positive returns over numerous years, spanning many decades.
The source of this success is diversification. Stocks and bonds have proven to be a complementary investment dynamic duo. Often, when one is zagging, the other one is zigging. Stocks give investors participation in the economic benefits created by companies and primarily deliver the growth in a portfolio. However, stocks are inherently volatile in the short term and can exact a toll on portfolios in periods of market volatility. Bonds, on the other hand, are relatively more stable and serve two key functions in a balanced portfolio. They are a primary source of income, and they are less volatile, serving as the portfolio’s ballast in periods of stock volatility. Bond stability in the face of equity volatility has been one of the key attributes of the 60/40 and similar balanced portfolios. Since 1926, a portfolio allocated 60% to U.S. large cap stocks and 40% to U.S. core bonds has been positive in 75 of these 97 calendar years, a 77% success rate.
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