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- For years, I've been hearing financial experts declare the death of the 60/40 portfolio, where 60% of your assets are invested in stocks and 40% in bonds. But I tell my clients to ignore that advice.
- The 60/40 portfolio has continued to deliver results — even in 2020, a wild year, the allocation is up around 10%.
- There are many reasons experts say the portfolio is dead, from financial theory to self-interest, but I continue to recommend a 60/40 allocation to many clients.
- SmartAsset's free tool can find a financial planner to help you take control of your money »
For years, I have heard financial pundits, financial advisors, and asset managers scream out that the 60% stock/40% bond portfolio is dead. It is, in fact, not dead, and in actuality has done quite well.
While we cannot credit one specific individual for the creation of the 60/40 portfolio, we should give some credit to the man one could argue made it popular, Jack Bogle. Bogle, the founder of Vanguard, created the Vanguard Balanced Index Fund in 1992, seeking a way to invest that would allow for asset appreciation without gut-wrenching drawdowns. Today, that fund manages over $46 billion, and there are many similar mutual funds and exchange-traded funds managing many billions more.
How the 60/40 portfolio works
Whether you invest in the Vanguard Balanced Index Fund or a similar type of investment, the strategy is the same: Diversify your assets between stocks and bonds so you aren't over-exposed to either market. When stocks inevitably get overpriced and then selloff, your bonds should maintain their current value or even appreciate. These gains and losses will alter your allocation, so you may end up with a 55/45 stock-to-bond ratio at the end of the year.
Here is the key to why this portfolio works well over time: At the end of the year, or another chosen time, your portfolio is rebalanced. The assets that performed well are sold, and the assets that have underperformed are purchased, realigning the portfolio to the original 60/40 allocation.
Why do experts say this portfolio is dead?
So why have financial experts been calling for the death of this portfolio for so long? For some, it's about investing principles. For others, it's financial theory. And then for a few, it's self-interest.
The 60/40 portfolio is based on the principle of passive investing — don't try to beat the market; adjust your risk to the expected volatility of your asset allocation and be happy with what you get. This type of investing has exploded in popularity over the past couple of decades. However, despite an overwhelming amount of research, there are still many who argue that active investing is superior to passive. Why simply accept what the S&P 500 returns year-in and year-out, they ask. Instead, you should be attempting to outperform that market.
Those who don't believe in passive investing point to active investors who have been successful as proof. Warren Buffett is one who is always referenced, although even Buffett has struggled in recent years to outperform the S&P 500 and heartily recommends passive investing to everyday investors.
Financial theory has also played a part in calls for the demise of the 60/40 portfolio. The belief is that we have been in a multi-decade bull market for bonds because interest rates have only gone down since their peak in the early 1980s. As interest rates fall, bond prices rise, much like the action of a see-saw. Therefore, if interest rates can't fall any more, bond prices can't rise any further. And since the Fed's interest rate is currently near zero, there's virtually no more room for growth, so a 40% bond ratio is no longer profitable.
This argument does make sense, but what it may not have accounted for was how much low interest rates would positively impact stock prices and other financial assets. Even if rates don't drop any further, with the amount of debt our country is in — along with businesses, states, counties, and individuals — it is unlikely interest rates will rise any time soon. If rates don't rise meaningfully, bond prices won't be as negatively impacted as these forecasters believe.
Finally, some argue against this portfolio simply because it is in their self-interest. If I managed a hedge fund, private equity fund, or a real estate investment trust, it would not exactly be beneficial to my business to go around on TV and in the newspapers saying the 60/40 portfolio made sense for most investors (and even large institutions) since it doesn't require my active management.
The 60/40 portfolio continues to deliver results
Despite its detractors, the 60/40 soldiers on year after year. If we look at its performance from January 2000 through the end of October of this year, it has compounded at an annual rate of 7.31%. This would be even better if we accounted for November and December 2020, when the S&P 500 shot up over 11.8%.
The portfolio's best year, in 2019, returned 24.45%. The worst year, 2008, returned -13.21%, and the biggest drawdown, -26.96%, was between November of 2007 and February of 2009, but the portfolio recovered its value by April of 2010.
Actual results for an investor would be different, because we can't directly invest in indexes without incurring any costs, at least not yet. However, even with some associated costs, this type of allocation has done quite well over a couple decades, which has continued even in recent years. The allocation was up 7.57% in 2016, 16.44% in 2017, down -3.48% in 2018, again up 24.45% in 2019, and year-to-date, despite all the headwinds we faced in 2020, up around 10%.
Calling for the end or the death of something takes the ability to forecast, and I will leave you with two of my favorite quotes on that particular subject:
"Forecasts create the mirage that the future is knowable." —Peter Bernstein
"We have two classes of forecasters; those who don't know – and those who don't know they don't know." — John Kenneth Galbraith
Charles Weeks is the founding partner of Barrister, a registered investment advisor.
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