Going Beyond A 60/40 Asset Allocation

The classic portfolio breakdown is 60% stocks and 40% bonds, with the idea that the two asset classes move in opposite directions and will counterbalance each other in bad times. That concept went wrong in the nasty investing climate of 2022, when both types of securities tanked. We asked Lewis Walker, a financial planning and investment strategist at Capital Insight Group in Peachtree Corners, Ga., how to approach asset allocation now.

Larry Light: What’s your take on 60/40 now?

Lewis Walker: For years Wall Street gurus espoused an asset allocation model of 60% stocks, 40% bonds. The idea was that a generous allocation to equities would provide for long term growth, with a modicum of dividends, while bonds offered interest income and a potential cushion during periods of market stress. Easy guidelines to follow have appeal that’s based on simplicity. Reality generally is a bit more complicated, as a truly diversified investment portfolio is likely to contain more than stocks and bonds.

The drops in equity values along with a concomitant rout in the bond markets in general in 2022 have several large asset managers arguing over the pros and cons of the 60/40 strategy. The rigid allocation model may be akin to declaring that a fruit salad should always contain 60% apples and 40% bananas. What about berries or exotic options such as mangoes, passion fruit, coconut, etc.?

Light: In light of that, how should we choose placing our assets?

Walker: A diversified investment portfolio will likely contain more than stocks and bonds. Even stocks and bonds offer a plethora of choices. You may elect individually self-selected stocks, mutual funds or exchange-traded funds, known as ETFs, as well as professionally managed portfolios of various holdings including individual stocks. Bonds come in various formats, similar to equity offerings. Some formats may include stocks and bonds in the same portfolio, as in a balanced fund.

Equities offer a variety of choices akin to a diverse restaurant menu. Large cap-capitalization stocks, mid-cap, small-cap, micro-cap? What would you prefer today: U.S. stocks, non-U.S. stocks? What about investment style: growth, growth at a reasonable price known as GAARP, value, deep value? Dividend-paying stocks, non-dividend payers focused on growth? Utilities? Where do strategies such as option writing, meaning puts and calls, come in, if at all?

Light: When it comes to cash or bonds, what mix is appropriate?

Walker: Treasury bills, notes, bonds? Money market funds, certificates of deposits, corporate bonds, municipal bonds, other types of debt instruments? Again, you have choices as to individual holdings, mutual funds, ETFs and separately managed portfolios.

Light: But you advocate looking at asset classes beyond stocks and bonds.

Walker: You may want to mix in alternative investments in various forms such as real estate, private equity, precious metals or other assets. Perhaps you own a closely held business that is your largest single investment. How does growing the value of that asset play into other investment and planning choices?

If you are confounded in a fine restaurant by a complex and diversified menu with an extensive wine and cocktail list, you are likely to turn to an experienced waitress or waiter and ask, “What do you suggest?” In the same way, you might turn to an experienced financial advisor to suggest what mix of planning options and investment choices is right for you.

Light: How can an advisor help you?

Walker: To determine what is appropriate for you, before any recommendations are made, a client-centered advisor will have a series of discussions with all parties involved. This means you, of course, as well as your spouse or partner depending on the circumstances, and perhaps an adult child who may have to step up given your incapacity or death.

As with choosing the makeup of your portfolio there are a multitude of variables: your age and time frames, goals and objectives, health status, number of dependents and their time frames, other family obligations such as aging parents or a special needs child, current net worth, debt levels and cost of debt, need for liquidity, your understanding of risk versus reward, and your mental and financial ability to deal with risk.

An advisor would want to understand your story. How did you get to where you are and where do you see yourself in the short-, mid-term, and long-range future? What do you want your money to do for you? Do you understand risk?

Light: As always, the question of risk tolerance is a factor.

Walker: Risk is a tricky concept. Some people will tell you that they can tolerate risk, only to change their mind when confronted with loss. Markets fluctuate. Some investments do well, some okay, some lose money. With some speculations (like the recent crypto fiasco), the value of the investment may go to zero. If you’re going to take a flyer, the question would be, “If you lost your entire investment in XYZ Ventures, would it imperil your lifestyle?” If your answer is yes, don’t invest.

In any well-diversified portfolio, performance in any one sector will vary from time to time. But the assumption is that over the long run, the portfolio will grow to meet your goals. Beyond investment strategies, you must look at the “what if?” vicissitudes of life.

A comprehensive financial plan encompasses elements of living and testamentary estate planning, application of various insurance tools, tax planning, special needs planning and charitable giving. For the business owner, concepts of “value acceleration” are critical for dealing with what may be your largest single investment asset, your lifestyle business or enterprise.

Light: So it pays to look beyond 60/40?

Walker: The allocation model of 60/40 is not as simple as it looks. The proportion, or something similar, may be a good starting point and a useful rule of thumb periodically, but there are many other factors to consider.

Kofi Annan, former Secretary-General of the United Nations, noted, “To live is to choose. But to choose well, you must know who you are and what you stand for, where you want to go and why you want to get there.” Your financial plan should reflect your journey and your goals and expectations. Choose well, indeed.