Inflation and rising interest rates have stressed the 60/40 investment portfolio strategy — ‘but it’s not dead,’ says financial advisor

The 60/40 portfolio is under fire.

But should investors sound the death knell for the classic investment strategy? Financial advisors and experts don’t think so — but it likely needs a tweak.

“It’s stressed but it’s not dead,” said Allan Roth, a certified financial planner based in Colorado Springs, Colorado.

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The strategy allocates 60% to stocks and 40% to bonds — a traditional portfolio that carries a moderate level of risk.

More generally, “60/40” is a shorthand for the broader theme of investment diversification. The thinking is: When stocks (the growth engine of a portfolio) do poorly, bonds serve as a ballast since they often don’t move in tandem.

The classic 60/40 mix encompasses U.S. stocks and investment-grade bonds (like U.S. Treasury bonds and high-quality corporate debt), said Amy Arnott, a portfolio strategist for Morningstar.

Until recently, the combination was tough to beat. Investors with a basic 60/40 mix got higher returns over every trailing three-year period from mid-2009 to December 2021, relative to those with more complex strategies, according to a recent analysis by Arnott.

Low interest rates and below-average inflation buoyed stocks and bonds. But market conditions have fundamentally changed: Interest rates are rising and inflation is at a 40-year high.

U.S. stocks have responded by plunging into a bear market, while bonds have also sunk to a degree unseen in many years.

As a result, the 60/40 portfolio is struggling: It was down 17.6% this year through June 22, according to Arnott.

If it holds, that performance would rank only behind two Depression-era downturns, in 1931 and 1937, that saw losses topping 20%, according to an analysis of historical annual 60/40 returns by Ben Carlson, the director of institutional asset management at Ritholtz Wealth Management.

Of course, the year isn’t over yet; and it’s impossible to predict if (and how) things will get better or worse from here.

And the list of other good options is slim, at a time when most asset classes are getting hammered, according to financial advisors.

“Fine, so you think the 60/40 portfolio is dead,” said Jeffrey Levine, a CFP and chief planning officer at Buckingham Wealth Partners. “If you’re a long-term investor, what else are you going to do with your money?

“If you’re in cash right now, you’re losing 8.5% a year,” he added.

“There’s still no better alternative,” said Levine, who’s based in St. Louis. “When you’re faced with a list of inconvenient options, you choose the least inconvenient ones.”

While the 60/40 portfolio may not be obsolete, investors may need to recalibrate their approach, according to experts.

“It’s not just the 60/40, but what’s in the 60/40” that’s also important, Levine said.

But first, investors ought to revisit their overall asset allocation. Maybe 60/40 — a middle-of-the-road, not overly conservative or aggressive strategy — isn’t right for you.

Determining the right one depends on many factors that toggle between the emotional and the mathematical, such as your financial goals, when you plan to retire, life expectancy, your comfort with volatility, how much you aim to spend in retirement and your willingness to pull back on that spending when the market goes haywire, Levine said.

While bonds have moved in a similar fashion to stocks this year, it would be unwise for investors to ditch them, said Arnott at Morningstar. Bonds “still have some significant benefits for risk reduction,” she said.

The correlation of bonds to stocks increased to about 0.6% in the past year — which is still relatively low compared with other equity asset classes, Arnott said. (A correlation of 1 means the assets track each other, while zero connotes no relationship and a negative correlation means they move opposite each other.)

Their average correlation had been largely negative dating back to 2000, according to Vanguard research.

The S&P 500 Index is down 21% in 2022 and the Bloomberg U.S. Aggregate bond index is down 11%.

“It’s likely to work in the long-term,” Roth said of the diversification benefits of bonds. “High-quality bonds are a lot less volatile than stocks.”

The current market has also demonstrated the value of broader investment diversification within the stock-bond mix, said Arnott.

For example, adding diversification within stock and bond categories on a 60/40 strategy yielded an overall loss of about 13.9% this year through June 22, an improvement on the 17.6% loss from the classic version incorporating U.S. stocks and investment-grade bonds, according to Arnott.

(Arnott’s more diversified test portfolio allocated 20% each to large-cap U.S. stocks and investment-grade bonds; 10% each to developed-market and emerging-market stocks, global bonds and high-yield bonds; and 5% each to small-cap stocks, commodities, gold, and real-estate investment trusts.)

“We haven’t seen those [diversification] benefits for years,” she said. Diversification “is like an insurance policy, in the sense that it has a cost and may not always pay off.

“But when it does, you’re probably glad you had it, Arnott added.

Investors looking for a hands-off approach can use a target-date fund, Arnott said. Money managers maintain diversified portfolios that automatically rebalance and toggle down risk over time. Investors should hold these in tax-advantaged retirement accounts instead of taxable brokerage accounts, Arnott said.

A balanced fund would also work well but asset allocations remain static over time.

Do-it-yourselfers should make sure they have geographic diversification in stocks (beyond the U.S.), according to financial advisors. They may also wish to tilt toward “value” over “growth” stocks, since company fundamentals are important during challenging cycles.

Relative to bonds, investors should consider short- and intermediate-term bonds over longer-dated ones to reduce risk associated with rising interest rates. They should likely avoid so-called “junk” bonds, which tend to behave more like stocks, Roth said. I bonds offer a safe hedge against inflation, though investors can generally only buy up to $10,000 a year. Treasury inflation-protected securities also offer an inflation hedge.