Putting 60% of a portfolio in stocks and 40% in bonds is supposed to hedge against both assets dropping simultaneously. But it didn’t pan out that way in 2022.
Inflation and rising interest rates whacked both asset classes, and a Bloomberg index tracking a 60/40 mix is down about 17% for the year. But some veteran investors say the classic approach to investing still makes long-term sense, and that bonds are positioned to regain their status as a good counterweight to stocks.
For long-term investors, the drop in stock valuations and the rise in bond yields in 2022 sets the stage for future average returns of 6.9% on the 60/40 mix, according to Leuthold Group, a market research and money management firm.
But those returns may come with more volatility than in the past, the report concluded.
Leuthold’s research used the S&P 500 as its stock proxy. But the stock portion of a 60/40 portfolio shouldn’t be entirely in US stocks, said Christine Benz, director of personal finance at Morningstar Inc.
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“I always think that’s how the mix is conventionally construed, but the experts don’t recommend that, and I certainly wouldn’t, either,” she said. “Most investors should have exposure to international equities and have some — not a lot, but some — cash on hand.”
Vanguard Group is also counselling patience with a 60/40 strategy, noting in a report that over shorter time frames it’s not that unusual to see stocks and bonds decline in concert.
Since 1976 there have been, on average, a month of joint drops about every seven months, the research found. But during that same period, “investors never encountered a three-year span of losses in both asset classes,” according to the report.
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Lasting logic
“For someone investing in a 60/40 portfolio for five years or more, the logic still holds,” said Roger Aliaga-Diaz, global head of portfolio construction at Vanguard and author of the report. “If you look at the last 10 years, including this year’s loss, the return is 6.5% for some 60/40 benchmarks, so on average it’s doing what it’s supposed to do — give you a 6% to 7% return.”
The equity portion of Vanguard’s benchmark 60/40 portfolio has 36% in US stocks and 24% in international stocks; the bond portion has about 22% in currency-hedged international bonds and 19% in US intermediate credit bonds.
Some investment firms advocate for a 60/40 mix to incorporate more asset classes, such as alternative assets. A recent report from private equity firm KKR & Co. proposed that investors devote 40% to stocks, 30% to bonds and then 30% to alternative assets, of which at least 10% should be private credit.
Investments such as private credit, real estate and infrastructure are more inflation-resilient, the report argued, and should provide better risk-adjusted returns over the long run. KKR found that the 40/30/30 portfolio outperformed a traditional 60/40 split by 2.6% over the 24-month period through June.
