As stocks and bonds sank in tandem this year, market watchers couldn’t help but wonder aloud: Has the traditional 60/40 portfolio outlived its usefulness?
“Considering the tough year for the markets, the chorus of the ‘death of the 60/40’ portfolio tends to get louder,” says Melissa Shaw, wealth manager at TIAA in Palo Alto, California. Shaw notes that the 60/40 portfolio is down more than 20% for the year, causing many financial advisors and investors to question the viability of the mix.
Here are some factors for financial advisors and others to weigh as they consider changes to the way assets are allocated in their portfolio:
— Pros and cons to a 60/40 portfolio now.
— Finding a suitable mix of assets.
— There’s no one-size-fits-all strategy.
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Pros and Cons to a 60/40 Portfolio Now
A portfolio consisting of 60% stocks and 40% bonds has become a default investing strategy for financial advisors. It offers the potential for market-tracking growth from stocks while using bonds to dampen volatility and preserve capital.
But as Shaw points out, the past year has been a brutal one for investors, as both stocks and bonds got walloped.
For example, in its most basic form, a 60/40 portfolio could consist of an S&P 500 exchange-traded fund such as the SPDR S&P 500 ETF (ticker: SPY) paired with a core bond vehicle such as the iShares Core US Aggregate Bond ETF (AGG).
“The traditional 60/40 portfolio could still make sense for pre-retirees, but clients are advised to consider their risk tolerance, their overall financial health and their need for income from the portfolio to have a more thorough picture of whether the 60/40 mix makes sense for their financial goals,” Shaw says.
Milind Mehere, founder and CEO of alternative investment specialist Yieldstreet, says low interest rates make bonds less appealing in the current market.
“The actual yields that investors receive from bonds are minimal and pale in comparison to the yield earned only 10 years ago,” he says. “Bond prices go up as interest rates go down, but we’re already near zero, so bond prices themselves have less room to go much higher, unless, of course, yields go negative as we have seen with government bonds in parts of Europe and Japan.”
An inflationary environment means that the dollar returns investors receive from a given bond will be worth less over time, Mehere adds.
“There’s no more popular cure to inflation than raising interest rates, potentially putting bondholders in a tough spot,” he says.
[READ: Vanguard vs. Fidelity: Which Is Best for You?]
Finding a Suitable Mix of Assets
Most advisors adhere to their fiduciary duty these days, and prefer that clients stick to a predetermined allocation, rebalanced at intervals, rather than panic trading in an effort to beat the market. But given the combination of high inflation, rising interest rates and the possibility of a recession, is there a mix of assets that’s suitable right now?
“Value stocks tend to perform better during challenging market conditions, while growth stocks perform better when market conditions are more favorable toward investors,” says Jeremy Bohne, founder of Paceline Wealth Management in Boston.
That’s because value stocks typically have more reliable profits, while growth stocks “need a lot of things to go right in order for them to meet expectations for high growth,” Bohne says. Markets witnessed that recently, when high-growth technology stocks and other industry categories suffered as pandemic-era stimulus money was no longer available, and interest rates began rising.
He adds that a challenge for bond investors is the lower rates on U.S. Treasurys, which tend to have long terms to maturity. This means they may face greater headwinds compared with other segments of the bond market, such as corporate, short-term or high-yield bonds.
Shaw says she considers the 60/40 portfolio to be a baseline or framework and believes sticking with that mix will be impactful for long-term returns. From there, an advisor or client can consider the current environment and make adjustments as appropriate.
“As an example, let’s say U.S. small-cap stocks are normally 2% of the portfolio. If an investor thinks we are coming out of a recession and economic growth will improve, small-cap stocks tend to benefit most during the upswing from a recession,” Shaw says. That allocation could be bumped up by two or three percentage points, as long as it conforms to strategic targets, she says.
“Or, an investor might say, ‘The future looks uncertain and U.S. bonds are paying me 4%-plus and I’d rather have more in bonds right now,'” Shaw adds.
[READ: Even Advisors Get the Blues: Managing Stress as a Financial Advisor.]
There’s No One-Size-Fits-All Strategy
An investor closing in on retirement should consider adding more guaranteed assets, which ensures that sufficient short-term income is available for withdrawal needs, Shaw says. Pre-retirees can also take advantage of bonds with depressed prices and improved yields.
“It is also a good time to consider tax-loss harvesting bonds and bond funds in taxable accounts and using the volatility to position into higher-quality or higher-yielding bonds, if available,” Shaw says.
Investors further from retirement who can handle risk should remain skewed toward equities, says Erik Weir, founder and principal at WCM Global Wealth in Greenville, South Carolina.
“Markets do go down, and it is important to remember that when they are down, buy more,” Weir says. Avoid selling in a panic when the market is down, he says.
He notes that equities have gone down as much as 30% recently. “If you look at the growth of the U.S. economy over 30 years, it is a good time to be in. It is a good time to buy if you’re not in,” he says. “If you’re in and down, it is a good time to add. But it goes back to perspective and timing. The more time in the market, the better the result.”
When it comes to the fixed-income allocation, Weir says a good mix would be 60% equities, 20% bonds and 20% cash. But that doesn’t mean the cash should be parked there indefinitely.
“It is worth considering taking the 20% cash and investing it monthly over the next year,” he says.
For stability of the sort that a 60/40 strategy is intended to convey, Weir suggests including not just stocks, but also 20% commodities, along with 10% cash and 30% fixed income. “This approach would likely be more stable than a simple mix of just stocks and bonds,” he says.
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Is the 60/40 Portfolio Dead? originally appeared on usnews.com
