close
close

The mom-and-pop investment strategy that has risen from the dead

Reports that the 60/40 investment portfolio is dead may be greatly exaggerated.

This traditional formula for determining how much of your nest egg should be allocated between stocks and bonds had one of its worst years in over a decade in 2022, when both asset classes collapsed simultaneously.

This led some to speculate that the old small family farm strategy may have outlived its purpose. Since then, however, the old standard approach has regained momentum due to the recovery in both stocks and bonds.

The 60/40 portfolio has returned 22.15 percent from January 2023 through the end of June this year, said Todd Schlanger, chief investment strategist at Vanguard, who is optimistic about the future of this strategy.

Stocks rose on excitement about the potential of artificial intelligence and growing confidence that the U.S. economy will make a soft landing. Bonds rose on expectations of an eventual interest rate cut by the Federal Reserve.

“Because of its diversification, it has performed consistently well in the past,” Schlanger said. “In terms of performance, it will never be at the top and it will never be at the bottom.”

“It is a very diversified strategy and we believe it will be very successful in the future,” he added.

Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2024 in New York City. Wall Street stocks opened little changed on May 17, after recovering from a record run that saw the Dow top 40,000 for the first time. About 10 minutes after trading began, the Dow Jones Industrial Average was steady at 39,872.66. (Photo by ANGELA WEISS / AFP) (Photo by ANGELA WEISS/AFP via Getty Images)Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2024 in New York City. Wall Street stocks opened little changed on May 17, after recovering from a record run that saw the Dow top 40,000 for the first time. About 10 minutes after trading began, the Dow Jones Industrial Average was steady at 39,872.66. (Photo by ANGELA WEISS / AFP) (Photo by ANGELA WEISS/AFP via Getty Images)

Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2024 in New York City. (Photo by ANGELA WEISS/AFP via Getty Images) (ANGELA WEISS via Getty Images)

The classic 60/40 strategy is a long-standing approach that involves investing 60% of the investment portfolio in equities and the remaining 40% in fixed income. Traditionally, bonds are used as a portfolio shock absorber and often rise in value when equity prices fall.

To further diversify the portfolio, investments within the equity and fixed income portion will be spread across the U.S. and international markets, Schlanger said.

The breakdown is as follows: The standard portfolio would consist of 60% US stocks and 40% international stocks, weighted by market capitalization.

In the fixed-interest portion, 70% are US bonds and 30% are global bonds.

“I consider it an all-weather portfolio because it is so diversified,” Schlanger said.

The key is consistent, not necessarily above-average returns. Over the long term, the 60/40 model has provided this consistency.

Since 1997, the average return has been 6.7 percent. And over the last decade, the return has been 6.2 percent, “even including 2022,” Schlanger said.

But 2022 posed a major challenge to the dominance of this approach. This year, the 60/40 portfolio declined by almost 16%.

Rapidly rising inflation, which peaked in June 2022, has hit both stocks and bonds. The S&P 500 lost over 19% of its value, while the Nasdaq plunged 33% as the Fed raised its benchmark interest rate in response to inflation, significantly increasing borrowing costs for companies.

At the same time, US bonds recorded their worst year ever as a result of the central bank’s aggressive anti-inflation campaign.

All of this has put a heavy strain on the 60/40 portfolio.

“It’s not unusual for stocks and bonds to fall at the same time … typically in times of inflation,” Schlanger said. “But 16 percent is one of the worst years we’ve seen for a balanced portfolio like the 60/40.”

However, a bad year should not deter investors from the 60/40 approach. Schlanger is even convinced that the reserve portfolio has good prospects for success again in the next decade.

While stocks supported the average return of the 60/40 approach over the past decade because bond yields were “below average”—they returned just 2% during that time—bond yields are now much higher.

“We expect bonds to play a more significant role in returns going forward,” said Schlanger. “The outlook could be much more balanced.”

However, the 60/40 portfolio is not suitable for everyone. A person’s risk tolerance and age also play a major role.

For example, Vanguard’s target-date funds for people in their 20s would invest 90 percent of their portfolio in riskier stocks, Schlanger said, because these people have a longer time horizon to offset any bad years on the stock market.

However, someone who retires later would only have invested 30 percent of their portfolio in stocks because bonds offer less risky returns.

“Investors go through different life cycles and their risk tolerance evolves over time,” Schlanger said. “That’s why we can’t say that the 60/40 ratio is right for everyone.”

Janna Herron is a senior columnist at Yahoo Finance. Follow her on Twitter @JannaHerron.