Archives for June 11, 2024

The “60/40” portfolio, made up of 60% equities and 40% bonds, has been a staple of investment management for several decades. The strategy gained mainstream acceptance after William Sharpe and Harry Markowitz won the Nobel Prize in Economics in 1990 for this portfolio optimization model. Mutual funds further popularized the investment strategy in the late 1990s and early 2000s. And it worked well for the better part of the past three decades, but is it still relevant today?

So, Why 60/40, Anyway?

The 60/40 portfolio has become the generic term for a diversified portfolio, with the mix between stocks and bonds varying based on the investor’s risk tolerance and goals. Stocks are held in hopes of capital appreciation growing the portfolio and maintaining purchasing power against inflation, but they also carry varying amounts of risk. Bonds, used in conjunction with stocks, provide safety and reduce volatility. Bonds worked well in portfolios in the 45-year period leading up to 2020, at which time interest rates steadily decreased. This period saw bond prices rise (as bond prices move inversely to yields), providing investors with income and rising values. Government bonds, in particular, acted as a strong equity hedge during the Great Financial Crisis of 2008 as interests quickly dropped while investors sought safety in U.S. Treasuries.

Recent Underperformance and Challenges

However, things have changed. Over the past few years, portfolios with a mix of stocks and bonds have underperformed due to rising interest rates pushing down bond prices. In response to inflation spikes post-COVID, the Federal Reserve raised short-term interest rates, resulting in some of the most significant bond losses of the last hundred years. The so-called “safe money” in bonds has not fared well over much of the last three years. While stocks have generally performed well, bonds failed to provide the expected protection during the stock market downturn of 2022.

The Outlook for Interest Rates and Bonds

Current expectations suggest that interest rates will drop, pushing bond prices higher, and enabling the traditional stock/bond portfolio to regain its strength. However, we are not fully convinced that this will be the case. The yield curve has been inverted (short-term rates higher than long-term rates) for nearly two years. When (if) the Fed does lower rates, the yield curve will likely normalize, with short-term rates dropping and intermediate to long-term rates holding steady or even rising. Short-term bonds will likely provide a positive return but those gains may be somewhat limited since gains in bond prices may be offset by the reduction in interest received as a result of lower rates. Long-term bonds offer limited upside, outside of interest paid, if long-term rates hold steady and create potential for further losses if rates rise.

Despite these challenges, fixed income yields are at their highest levels in nearly 20 years, so investors get “paid to wait” and collect interest. However, after accounting for taxes and inflation, real returns on many fixed income instruments are minimal and barely maintain purchasing power.

Adapting With Changing Markets

A diversified asset portfolio still makes sense to lower volatility and preserve capital. However, asset allocation should be dynamic and adjusted according to current economic and market conditions. Modern Portfolio Theory, introduced by Markowitz in 1952, was based on three asset classes: stocks, bonds, and cash. Today’s investment landscape offers considerably more strategies and options for generating income and protecting against stock market losses than there were in the past.

Secured Retirement Will Explore Your Options

If you haven’t already, it may be time to look beyond the traditional 60/40 portfolio and consider alternative strategies. There isn’t a single right or best way to build an asset allocation, but mistakes can lead to poor outcomes. With the help of a knowledgeable professional, each investor needs to find the balance that best aligns with their unique goals and objectives. If you’re struggling to find your balance, give us a call: 952-460-3290.