The 60/40 Portfolio Is On Track For A Horrendous Year, Here’s Why The Strategy’s Not Dead

The 60/40 portfolio is a widely regarded robust method of portfolio construction. For 2022 it’s been a disaster. Stocks have fallen sharply, and bonds are breaking records in the worst way possible. Then when you layer inflation on top, which has eroded purchasing power, the real returns are even worse. It’s tempting to want to give up on the 60/40 portfolio, but its long-term prospects are likely to be reasonably robust. If anything 2022 has made the long-term outlook for this portfolio construction a little better than it was.

The Logic Of 60/40

The 60/40 portfolio is a tried and tested ‘set it and forget it portfolio’ where you invest 60% of your long-term assets in stocks, typically a diversified index portfolio, and the remaining 40% in bonds. The logic makes sense. Stocks have historically seen attractive long-term returns, but can come with major short-term swings in value. Those big swings can be tough to stomach. Bonds have somewhat lower long-term returns, but can bring stability to a portfolio. Everyone’s investment needs are different, but a 60/40 portfolio gives exposure to the long-term attractiveness of stocks while arguably helping the risk-level approach something many investors can live with.

It’s worth noting that though 2022 is a terrible year for the 60/40 it’s still done it’s job to some degree. Bonds have held up better than stocks, hence the 60/40 portfolio has done better than portfolios that are more invested in stocks. Secondly, a diversified portfolio of stocks, as the 60/40 portfolio often implies, has proved less risky than more exposed investment bets. Those with large allocations to specific assets such as growth stocks, tech stocks or crypto have generally had a disastrous 2022, whereas again, the balanced exposure of the 60/40 portfolio has held up better. Of course, everyone wants positive returns, but those have been hard to come by in 2022, and the 60/40 has seen less of a loss in value than many other portfolio construction methods.

Prospects

Maybe the 60/40 portfolio has better prospects going forward. First lets take bonds. These can be reasonably easy to forecast, the returns to a portfolio of high quality, low risk bonds is equal to its current yield if you hold to maturity. At the start of the year you would have broadly expected a 1.5% return holding a 10-year U.S. Treasury for a decade. At current levels you might expect a shade under 3%. Returns to high quality intermediate fixed income has basically doubled. Of course, it required a lot of pain to get there, but it means the long term prospects for certain fixed income assets are a lot better than they were six months ago.

Then with stocks it’s a little harder to build a robust forecast, but valuations are returning to more normal levels, offering the prospects of more reasonable returns over the next decade. Again we couldn’t necessarily say that 6 months ago.

Abandoning the 60/40 portfolio today is a little like running out of the store because all the products are potentially on sale, or at least less marked up than they were. There’s likely more volatility to come, and it’s not certain that we’ve seen the low for financial markets, but its probable that the horrendous start to 2022, has set up a 60/40 for a somewhat better long-term performance than could have been estimated earlier in the year.