It’s become almost a trend in recent years to condemn the 60/40 portfolio, which invests 60% in stocks and 40% in bonds. And with good reason. Thanks to an absurdly low interest rate environment, it didn’t offer the same diversification benefits one would expect in a more reasonable world.
Yet investors need to recognise that, believe it or not, the 60/40 portfolio is far from dead. In fact, it may be poised to do better than it has at any time over the past decade: Despite stocks still behaving unpredictably, bonds are potentially on the cusp of a resurgence, and alternatives are failing to produce outsized returns.
A Crisis and Low Rates
The fallout from the 2008 financial crisis made many investors too comfortable with a long-term low interest rate environment. But in the wake of the Fed hiking rates since March 2022, the landscape has changed dramatically, with quality bonds perhaps becoming attractive over the long term.
The biggest indicator of how bonds will perform is current starting yields. Bond investors should not expect strong returns when current yields for 10-year Treasurys are, say, 1.5%. But when they are, say, 3.5%, that’s much more appealing. If a recession or stock selloff occurs within the next year, investors could do well to shift asset allocations into quality bonds in pursuit of greater portfolio diversification.
Alternatives Excess
In recent years, many investors have become overly enamoured with alternative investments, considering them almost bond-like, thanks to the reliable yields many had produced when interest rates were near zero. But much of what made them attractive in the recent past—an ultra-low rate environment—will be less applicable going forward if rates continue to rise.
In addition, various fees associated with alternatives make them pricey for investors, with typical expense ratios well over 1% versus under 0.4% for many bond funds.
Bond Support
Bonds, meanwhile, are much simpler to understand—and stand to provide better risk reduction and stability of returns than stocks or alts in the years ahead. Even if the Fed hikes rates a couple more times during this cycle, further tightening won’t impact the inverted yield curve as much as past increases, thanks to ongoing fears of an economic slowdown.
In other words, rates may be about to peak—which means bonds could be positioned for higher expected returns. The bottom line is that bonds struggled last year, which was a rare market environment. Now, the landscape is shifting fast and will likely get less atypical as a more traditional interest rate environment takes hold for the foreseeable future.
Portfolio Fundamentals
The fundamentals of investing—coupled with simplicity of execution—remain the best path to long-term financial success. To be sure, a small allocation to certain alternative investments may be worthwhile, depending on your overall financial circumstances—as well as your ability to truly understand those alternative strategies. Otherwise, though, investors shouldn’t listen to much of the outgoing noise and should embrace the value of pursuing a 60/40 portfolio strategy that utilises quality bonds and avoids heavy concentration on the momentum stocks of the day.
The value of investments, and any income from them, can fall and you may get back less than you invested. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Neither simulated nor actual past performance are reliable indicators of future performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy.