The case for the survival of the 60/40 portfolio – in two charts

The 60/40 investment rule of thumb has been killed and revived many times over the years.

Today, as equities (the 60s) and fixed income securities (the 40s) experience declines in value, this strategy is once again called into question. There are stronger calls for a more personalized mix of weightings in portfolios, including alternative investments such as real estate investment trusts (REITs), or even, due to higher interest rates, certificates of old fashioned deposit (CD).

Minneapolis-based investment research firm The Leuthold Group took a deep dive into asset allocation last October for both a historical look and considerations for the future. They haven’t come down definitively on the 60/40 side, but they do argue that, for long-term investments, it continues to show its value.

It’s true, research director Scott Opsal writes in the report, that “the 60/40 strategy is having a terrible year in 2022.” The results are clear in the first chart below, which shows the annual returns of a 60/40 mix of stocks and bonds, with both falling sharply this year.

Source: The Leuthold Group

Even so, the chart shows that, despite a bad year, the 60/40 strategy has worked quite well over time.

“Since 1976, there have been nine years where the 60/40 portfolio has posted negative returns,” writes Opsal. “Three of those years saw barely any negative results, and three others stopped before an overall loss of 5%. The only two annual declines of more than 5% came during the depths of equity bear markets in 2002 and 2008, and in both cases, bonds generated positive returns to temper the overall loss.

Then came this year, when the values ​​of the two together fell significantly.

And then ?

The question then is how to determine whether this is a failure in an otherwise good strategy, or a turning point. To get an answer, Opsal analyzed the “expected” returns for a 60/40 investment over time. He then matched that to year-over-year performance.

He found that the returns realized on stocks and bonds were “well above the returns expected quite often in recent years, as indicated by the bars that cross the green line”.

Source: The Leuthold Group

Through research, Opsal estimates that rising valuations “have boosted real annualized returns nearly 3% above expected return since the end of the 2002 tech crash through 2021.” Even with this year’s decline, the excess return over expected returns over the past 20 years is 1.5% annualized.

Going forward, returns could be even better, according to Opsal. The current decline in stock market valuations and rising bond yields have pushed estimated returns in a 60/40 mix to 6.9%, which “has significantly improved the attractiveness of 60/40 going forward.”

That said, the company also notes that stocks and bonds tend to have the same sensitivity to inflation and interest rates, and the opposite sensitivity to economic growth and unemployment. In short, “when inflation and interest rates dominate the conversation [today]we should expect a positive sign on the correlation,” or an increased downside risk in the market.

If a situation like the current one returns, “investors may be less willing to hold large equity allocations when they feel bearish,” writes Opsal.

Alternative Options

The rise of target date funds (TDFs), an age-based investment that generally allows for more risk when an investor is younger and becomes more conservative over time, shows that many people know that the 60/40 combination is not a one-size-fits-all solution. everything. TDFs have grown in popularity in recent years, especially among younger 401(k) participants, according to a May study by the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI).

Many are also using this moment to stress the need for alternative investments in portfolios, and research shows that financial advisors are taking notice.

Milind Mehere, founder and CEO of New York-based Yieldstreet, a digital wealth platform for alternative investments, says this is the natural evolution of investing.

He argues that institutional investors have already adopted alternative investment strategies and that the general public should now have access to them as well.

“What we’re really telling our investors is that you need to start modernizing your portfolio away from 60/40,” Mehere says. “Institutional investors are stuck at more than 50% in alternatives, but retail investors only invest at 5%. We need to start moving from 60/40 to 50/30/20 or something along those lines.

The Leuthold Group researchers note in their report that, as with most investment decisions, timing will be paramount.

2022 proved that “commentators were rightly skeptical of the strategy’s future prospects,” writes Opsal. “However, after experiencing a record correction this year, the 60/40 is again priced to offer reasonable expected returns, albeit with more volatility caused by a lower diversification benefit.”

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