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Enthusiasm for the 60/40 portfolio is arguably muted at this juncture in 2024. Yes, barely more than six months of market activity isn’t a great barometer for a portfolio methodology that is intended to be long-term.
On the other hand, that doesn’t obfuscate the fact that as of July 15, the S&P 500 is up nearly 19% year-to-date while the Bloomberg U.S. Aggregate Bond Index is higher by 0.6%. Over the past three years, “the Agg” is off 8%, providing runway for legitimate criticism of the 40 part of 60/40. Between the bull market in stocks and limited visibility as to when and to what extent the Federal Reserve will lower interest rates, it’s understandable that many advisors aren’t keen on having clients 40%-allocated to fixed income assets.
Advisors also know that outright ignoring bonds is a risky bet. Dramatically reducing or eliminating fixed income exposure at a time when yields are elevated is potentially dangerous because history confirms that the higher a bond’s yield is when an investor gets involved, the shorter the odds are of positive outcomes.
Point is 60/40 still has merit, but its credibility is enhanced with some alterations because the current environment calls for such adjustments.
With 60/40, Maco Environment Matters
Historically, a rising equity market on the back of a strong economy coupled with rising inflation hinders the 40 in 60/40 because nominal yields are usually high. The reverse is true in a recession and those two scenarios explain why 60/40 was a solid idea for decades.
However, neither of those situations as it play today. If anything, the economy of the past couple of years is highly unusual, historically speaking. That highlights the need to rethink 60/40.
“We believe these factors will slowly normalize, which means 60/40-like strategies should work again,” notes Serena Tang, Morgan Stanley’s Chief Cross-Asset Strategist. “While the levels of correlation and bond volatility going forward may look different from history, and definitely different from the QE period, as long as bonds have lower risks than stocks – and there’s little to suggest they won’t – bonds will continue to be good diversifiers.”
It’s encouraging that 60/40 is likely to work again in the future, but the implications there are 60/40 could ultimately mean 70/30 (or more in stocks) for some clients, 50/50 for others and so on.
Flexibility Is Key
The standard 60/40 construction has long called for the 40 sleeve to be comprised largely or entirely of Treasurys, but advisors don’t need to be that rigid. After all, with bond yields currently high, clients that aren’t near retirement would be better served with some elements of risk/reward in their fixed income portfolios.
“Or maybe, just maybe, there is another solution. Instead of a simple 60/40 like strategy, investors can look beyond government bonds to other diversifiers, and building a multi-asset portfolio with more flexibility,” adds Tang.
Bottom line: Flexibility is key when it comes to 60/40 and that includes acknowledging that the 40 can be reduced and other asset classes merit inclusion.