Is It Time to "86" the 60/40 Portfolio? Not Hardly. Why 60/40 Still Matters

For decades, the so-called 60/40 allocation target has stood as an investing guidepost. The 60/40 portfolio is a suggested recommendation for investors to allocate 60% of their portfolios to large-capitalization or S&P 500 stocks and the remaining 40% to Treasuries and investment-grade bonds (and other fixed-income investments). This portfolio allocation suggestion has been around a long time, which makes the 60/40 target “seasoned,” or perhaps “aged.” But it’s certainly not “dead,” contrary to some naysayers.

The 60/40 target has its share of critics—for example, some have pooh-poohed the role of bonds in portfolios amid the rock-bottom interest rates of recent years. However, 60/40 can still be a useful reference point for investors, and there are ways to diversify beyond traditional stocks and bonds while still using a 60/40 model to help build and protect a long-term nest egg.

Here are a few questions and answers to consider about the 60/40 investment portfolio target.

What’s the Rationale Behind the 60/40 Portfolio? 

Historically, 60/40 has been used as baseline for portfolio diversification. The basic idea is that by having more money in stocks, investors may gain more exposure to the stronger potential returns equities have historically generated. But by also holding lower-risk assets such as bonds, they might have some protection from market downswings and tumult.

The 60/40 target sets the stage for long-term, balanced investing. Equities may go through wide price swings when market volatility surges, but such periods also create opportunities to rebalance a portfolio (given the lower volatility of bonds), or periodically change the mix of stocks, fixed income, and other assets depending on how much prices change. The idea is to accumulate assets over time while managing risk in a disciplined way. The prompt to rebalance is one of the reasons the 60/40 portfolio has been helpful for investors in balancing risk and return.

How Has the 60/40 Target Performed Over Time?

Generally speaking, a 60/40 model has helped investors accumulate assets over long periods of time. The benefits tend to come during times of crisis, when the portfolio offers some durability. 

Over the past 50 years, a 60/40 portfolio posted an average annual return of 10.7%, according to Michael Batnick, director of research at Ritholtz Wealth Management LLC. (Batnick cited the S&P 500 Total Return Index and Bloomberg Barclays U.S. Aggregate Bond Index.) The 60/40 portfolio fell 20% or more in a year just once and gained 20% or more in 10 different years, as Batnick explained in a June blog post.

What Are the Knocks on 60/40?

One potential drawback to the 60/40 portfolio is that risk is skewed toward equities. About 90% of variation is driven by stocks, and there are certain market conditions when a 60/40 target doesn’t do so well, such as when the market is going through deep stress and all classes of assets are down (although even then, bonds may lose less value than stocks).

Some people question whether bonds should comprise as much as 40% of a portfolio when interest rates are scraping along at rock-bottom levels. For example, there are “good reasons to reconsider the role of bonds in your portfolio” and to allocate a greater share toward equities, Bank of America Securities analysts wrote in a November 2019 report titled “The End of 60/40.”

“The relationship between asset classes has changed so much that many investors now buy equities not for future growth but for current income, and buy bonds to participate in price rallies,” the analysts wrote.

How Can Investors Diversify Outside Traditional Stocks While Using a 60/40 Target?

Critics of 60/40 raise fair points. Still, for investors building a retirement nest egg or otherwise planning for the long haul, a 60/40 target is one way to help accumulate value while aiming to balance risk and return.

There are different avenues investors can consider for diversifying the 60% equity allocation. For example, an investor may want to increase the breadth of exposure by layering in small-cap stocks. Another consideration is diversifying between stocks that may potentially provide capital appreciation and growth and stocks that pay dividends or are more value oriented. Investors might also diversify internationally into, for example, European stocks, or in Asia and other emerging markets. The idea should be to seek higher growth potential across the global economy.

How Can Investors Diversify the Bond Portion of Portfolios?

Similar diversification tactics can be applied to bonds and other fixed-income assets. Treasuries are a traditional safe harbor and remain an important part of portfolio strategy. But with 10-year yields under 1%, it might be worth considering other, higher-yielding vehicles, such as investment-grade and high-yield corporate bonds.

Going a step further, investors might want to look outside the United States. Consider the sovereign debt of developed economies like the UK or the European Union, or emerging-market debt that’s issued in dollar denominations as well as local currency denominations.

Considering these diversification tactics in equities and bonds could provide global diversification to an investor’s portfolio.