The 60/40 standard of stock-investing isn’t working. You need a new look at the market
Rules are meant to be broken, and it looks like the 60/40 standard for holding stocks and bonds in a portfolio might have met its match last year.
The idea behind this asset-allocation measure is to hold roughly 60% of your investments in stocks and the other 40% in bonds and cash. Stocks tend to perform best over time but hit rough patches here and there. Bonds and cash don't return as much but also aren't so volatile.
“This, of course, is the core idea behind having both assets in a diversified portfolio,” noted Nicholas Colas, co-founder of Datatrek Research, in a recent commentary.
Since 1950, a 60/40 portfolio mix would have generated positive returns in 60 of those years, with only 13 calendar-year declines, according to J.P. Morgan Asset Management. But that's not the case lately, with both stocks and bonds pressured by the Federal Reserve’s policy of raising interest rates to quash inflation. Both stocks and bonds logged unusually poor results last year, lessening the benefits of holding both in a portfolio, regardless of the percentage weightings.
In fact, 2022 was one of the worst years ever for a portfolio of roughly 60% stocks and 40% in bonds. An investor with that mix would have lost about 16%, according to J.P. Morgan. The only worse years since 1950 for a 60/40 mix were 2008, down 20%, and 1974, down 17%.
"The 60/40 portfolio has long been revered as a trusty guidepost for a moderate-risk investor,” wrote Wendy Lin, a senior market strategist at Goldman Sachs Asset Management. “However, the tables turned in 2022 with a 60/40 portfolio experiencing one of its worst years on record as both sides of the portfolio came under pressure.”
Over the 10 years through 2021, a 60/40 portfolio would have generated strong annual returns of around 11% on average, Lin noted, but the results over the tough 2000-2009 stretch were just 2.3% yearly.
Looking ahead, her advice to investors is to lower future expectations with this strategy, focus more on income rather than capital gains and seek out opportunities in less-familiar areas such as emerging stock markets, private equity and real estate.
Best viewed as a starting point
Still, one nice thing about the 60/40 rule, in addition to generally good results over time, is simplicity. Asset allocation advice can get complicated, but this rule is pretty straightforward.
That said, many investors rightly view it as a starting point around which to make further refinements. The exact percentages were never chiseled in stone, and even categories such as “stocks” and “ bonds” are vague. For reasonable diversification on the stock side, for example, you might want a mix of small and large companies (or the funds that hold them) along with foreign holdings. The bond mix could include government and corporate issues and bonds with different maturities.
And rather than a precise 60/40 mix, you might prefer a percentage equal to 100 minus your age in the stock portion, with bonds and cash constituting the rest, then rebalance yearly. If you’re 55 years old, for example, you would hold 45% in stocks. At age 60, you’d be down to 40%. As you age, your portfolio thus would grow more conservative. But if you see it as too conservative, you could adjust by using 110 minus your age as the starting point.
Withdrawal rates a factor
With most diversified asset-allocation mixes, the idea is to generate strong investment returns over time while holding enough cushion to ensure the portfolio doesn’t get decimated in a challenging year like 2022. Another factor eventually comes into play — how much you can prudently withdraw along the way?
Jack Bowers, executive editor of Fidelity Monitor & Insight, an investment newsletter focused around funds in the Fidelity Investments lineup, wrote in his March newsletter that he took a fresh look recently at an allocation of 53% stocks and 43% in bonds that was popularized by investment adviser Bill Bengen about 30 years ago. This allocation, slightly more conservative than 60/40, is geared to new retirees and includes another rule in the form of a 4% annual withdrawal rate. That’s considered a reasonably sustainable level for people seeking to live off their investments but also wanting the portfolio to last at least 30 years, Bowers said.
The approach also assumes you rebalance annually back to that original 53/47 mix, such as by selling some stocks and investing the proceeds in bonds after years of strong equity returns — or doing the opposite after a year when stocks took it on the chin.
Bowers indicated Bengen’s original advice stands the test of time but added that a few modifications can improve the odds that your money will last. One is by withdrawing less during or after years when the portfolio fell sharply.
“That could mean you’ll have less money available to cover living expenses in a year like the present one, but the (withdrawal) cap allows time for your portfolio to recover, greatly increasing the odds it will last more than 30 years,” Bowers wrote. Big withdrawals can do particular harm during the first few years in retirement, he added.
Investment researcher Morningstar also looked at sustainable withdrawal rates recently and concluded that 3.8% is a reasonably safe bet for investors with a balanced portfolio seeking to have the money last at least 30 years. Morningstar based this on a portfolio comprised of 50% stocks and 50% bonds and thus one that's a bit more conservative than a 60/40 mix.
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This article originally appeared on Arizona Republic: Why investors should reconsider traditional ratio of stocks and bonds