Diversification lines the bedrock of long-term investing. By spreading your dollars across a mix of asset classes, sectors and industries, you help reduce the risk of substantial portfolio losses in any given year.
And for decades, the 60/40 rule has been a cornerstone of diversification. A 60/40 investment strategy allocates 60 percent of holdings to stocks — a high-risk, high-reward asset — and 40 percent to bonds — long considered boring but dependable. The idea is that one helps balance the other, offering 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 Laureate Harry Markowitz in 1952.
While many analysts and experts predicted the demise of the 60/40 rule at the close of 2022 — a particularly brutal year for both stocks and bonds — this long-term investment strategy is looking favorable once again in 2024 and beyond.
What is the 60/40 rule?
The 60/40 portfolio is a simple investment strategy that allocates 60 percent of your holdings to stocks and 40 percent to bonds. It’s sometimes referred to as a “balanced portfolio.”
The 60/40 rule has been widely recognized and recommended by financial advisors and experts for decades. The idea is that over the long haul, stocks have historically provided higher returns, while bonds offer fixed income and can act as a buffer during market downturns.
While the 60/40 split is a starting point, experts agree that the standard allocation should be tailored to an investor’s risk tolerance, time horizon and goals. A younger investor with a higher risk tolerance may take a more aggressive 80/20 approach, for example, while a recent retiree may favor a 40/60 approach.
Criticism of the 60/40 rule grows in 2022
Both stocks and bonds plunged in 2022. High inflation, rising interest rates and concerns of a looming recession caused the S&P 500 benchmark index to slump 18 percent. The Total Bond Index, which tracks U.S. investment-grade bonds, lost more than 13 percent.
If you held a 60/40 mix of stocks and bonds in 2022, you would have lost 16 percent, according to calculations by Vanguard. Neither stocks nor bonds helped soften the blow to investors’ bottom lines.
Many analysts and strategists criticized or at least voiced skepticism about the 60/40 portfolio, which failed to protect investors from a historically volatile year. Data from JP Morgan Chase noted that 2022 was among the worst years for a 60/40 portfolio since the mid-1970s.
“We think investors have many reasons to be concerned that the 60/40 might be dead,” a Goldman Sachs brief noted 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 rebounded in spectacular fashion as 2023 came to a close.
Stocks zoomed in November and December, fueled in part by news from the Fed of anticipated rate cuts in 2024. In 2023, the S&P 500 rallied 24 percent and the NASDAQ 100 cinched a stunning 55 percent gain — the tech-heavy index’s best annual performance since 1999.
Another reason for the renewed optimism: Higher bond yields today presage more attractive future returns, especially if prevailing rates cool off from their 2023 highs.
“With higher yields today, coupled with cooling inflation and a Fed that’s likely to cut rates this year, bonds should continue to provide support when added to a portfolio of stocks,” says Collin Martin, fixed income strategist with the Schwab Center for Financial Research.
Factors that resulted in the 2022 decline in bond prices — record-low bond yields and the start of the most aggressive series of Fed rate hikes in decades — have ceased to exist.
“We believe 2022 was the anomaly,” says Martin. “Today, bond yields remain near their highest levels since the global financial crisis, meaning there’s a lot more income to be earned that can help offset potential price declines should they occur.”
Vanguard, the second-largest asset management company in the world, raised its U.S. bond return expectations over the next decade to a nominal annualized 4.8 – 5.8 percent. Compare that with the 1.5 – 2.5 percent it expected before the Fed began hiking rates in March 2022.
In its economic and market outlook for 2024, Vanguard anticipates interest rates will remain above the rate of inflation for several years, offering a stable base for long-term risk-adjusted returns.
That spells good news for well-diversified investors and followers of the 60/40 rule. In fact, November 2023 was the best month for the classic stock and bond allocation since 1991, according to a Bank of America Global Research report. In a similar vein, a portfolio with a 60 percent weighting in the Morningstar U.S. Market Index and a 40 percent weighting in the Morningstar U.S. Core Bond Index netted returns of 18 percent in 2023.
Will stocks kill the 60/40 rule?
Still, the rekindled appreciation for the 60/40 portfolio may soon fizzle once again. The outlook for bonds is bright, but prospects for stocks have dropped following 2023’s red-hot year-end rally.
The average expected nominal returns for U.S. stocks over the next 10 years is just 5.5 percent, compared to the 11.6 percent average over the past 10 years, according to projections from seven major asset-management firms analyzed by Moringstar.
“It looks like the 60/40 portfolio may have returned, but how long it lasts is a different story,” says Lawrence Sprung, a certified financial planner and founder of Mitlin Financial. “It will be interesting to see how that plays out over the year.”
At its core, the 60/40 portfolio is meant to play the long game. It’s not meant to be tweaked and adjusted each time the market takes a nosedive. While it’s easy to criticize traditional balanced portfolios for not adjusting to market changes, creating a more effective strategy is challenging. The best way to react to market shifts, especially fundamental changes, is usually clear only in hindsight.
Bottom line
Despite its imperfections, the 60/40 rule remains a solid starting point for portfolio construction, thanks to its simplicity and proven long-term resilience.
“Many times investors get in trouble by simply making changes based upon current events,” says Sprung. “The 60/40 rule is good for providing structure and discipline to an investor’s portfolio.”
So, you might say the 60/40 rule is back again, though proponents would argue it never really left.
