In the wake of last year’s challenging investment environment, some market watchers are asking if the 60/40 portfolio is dead. Articles from Barron’s, Kiplinger, and other financial outlets splashed headlines trumpeting the investment strategy’s demise.
Before we declare the 60/40 dead, let’s take a closer look at the subject. A 60/40 portfolio is one that is made up of 60% stocks and 40% bonds. While it can be made up of individual stocks and bonds, in most cases portfolios will use diversified investments such as mutual funds and ETFs to follow this strategy. Some of you may know 60/40 by another name as a balanced fund with Fidelity, Vanguard, and Schwab all offering funds that target 60% stocks and 40% bonds.
There’s no sugarcoating that last year was brutal for the 60/40 portfolio. The Morningstar US Moderate Target Allocation Index fell 15.3% in 2022. Depending on what data you use and whether you consider inflation, it was the worst performance since the Global Financial Crisis of 2008 or the Great Depression. What was particularly unmooring about last year is that bonds are normally seen as a protected harbor during stormy stock markets. But with the Bloomberg US Aggregate Bond Index down over 13% last year, the supposedly safe harbor was pretty bumpy.
One poor year a bad strategy does not make. One year of below average performance does not augur that markets will continue to perform this way. If anything, it may be a better time to use a 60/40 strategy than the last few years. Keep these thoughts in mind when deciding whether the 60/40 may make sense for you despite last year’s performance.
Yield is a useful predictor of bond performance
If you want to know how much interest a bond fund pays, a good place to start is the SEC yield. This standardized formula considers the investment income that a fund has earned over the last 30 days less fund expenses. Many studies have shown that there is a strong relationship between yields and future bond performance. The yield of short-term Treasury bonds has climbed quickly with one year Treasury bonds now yielding almost 5%, and two-year bonds yielding 4.6%. If 40% of your portfolio is in bonds, it’s reasonable to expect that returns will be likely higher in this portion if your portfolio than they have been in recent years.
Investments tend to recover a year after entering bear markets
Investors remember that last year started with a bust as the S&P 500 set its high on Jan. 3, and then proceeded to cross into bear market territory on June 16, last year. Bear markets average about 9.6 months in duration, so our current bear has grown very long in the tooth. Over the last 65 years, the broad U.S. market has done quite well on average one year after entering a bear market. We cannot know if this pattern is set to repeat itself, but it should reassure investors who fear that we’re destined for moribund stock performance this year.
The 4% withdrawal rule
Bill Bengen’s 1994 paper on the four percent withdrawal rule is among the most cited in financial planning. It states that since 1926, a portfolio made up of 50 to 75% stocks and the remainder in bonds has lasted 30 years when taking out 4% of the portfolio balance in the first year of retirement, and then adjusting for inflation after that point. The 60/40 falls neatly into this range.
The “40” is good for calming the nerves
Among the worst investment strategies you can use are those that cave into the tyranny of our natural fight or flight response. When the stock market goes haywire, it’s comforting to have short-term, high-quality bonds at the ready. There’s nothing worse for the constitution of a retiree to withdraw funds for their living expenses from a portfolio made up of assets in decline. If the investor can focus on the stability of bonds in bear markets, it can help give them the persistence to invest in stocks, which are necessarily a volatile affair but a critical one if long term growth is needed to support your financial independence.
My final note about the 60/40 death watch crowd is to beware making predictions that are based on what has happened in the immediate past. It’s akin to driving with your eyes mostly on the rear-view mirror. While we care where we have been, it’s not necessarily the same place as where we are going.
David Gardner is a CERTIFIED FINANCIAL PLANNER™ professional at Mercer Advisors practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice. They reflect the judgment of the author as of the date of publication and are subject to change. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services.