Reports of the death of the long-standing 60/40 investment model – where 60% of a portfolio is allocated to equities to drive growth, and 40% to bonds to generate income and stability – are almost certainly greatly exaggerated, to paraphrase Mark Twain. True, the model failed in 2022, when both bonds and equities fell sharply, but over the longer term it has served investors very well. Moreover, there are signs that the inverse correlation between equities and bonds is normalising in 2023.
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Why the 60/40 portfolio allocation model remains relevant
The exception that proves the rule?
The 60/40 portfolio has long been held up as the ideal template for investors seeking moderate risk. And for many decades, this model, in which equities drive growth and bonds act as an anchor when financial markets encounter rough weather, has delivered excellent returns. That’s because equities and bonds typically exhibit an inversely correlated relationship: when equities go up, bonds tend to fall and vice versa.
Until 2022, that is. Last year proved an annus horribilis for 60/40 adherents, with both stocks and bonds falling sharply. The MSCI World Index of global equities fell by nearly 16% in local-currency terms. Meanwhile, the yield on the global benchmark for fixed income, the 10-year US Treasury, more than doubled over the year, rising from 1.5% at the end of 2021 to 3.84% at the end of December 2022, its largest increase since the 1960s.
It’s little surprise, then, that the media has been full of articles asking if the 60/40 approach is dead. However, it would be extraordinary if investors turned their backs entirely on a strategy that has served them well for most of the past century. Before 2022, there were only two calendar years in which both stocks and bonds declined: 1931 and 1969.1
Figure 1: the 60/40 model has delivered healthy returns with much less risk than a pure stock portfolio
Better times ahead?
The benefits of the 60/40 model have reasserted themselves already this year. By the end of June, the yield on the 10-year US Treasury was unchanged from its 2023 starting point, at 3.84%, while US and global equities have surged upwards. The MSCI World Index of global equities rose by 19.13% over the first six months of 20232, with US equities up by 15.9% as measured by the S&P 500.3
If it ain’t broke…
Many commentators have advised investors to stick with the 60/40 model but refine it by adding alternative assets etc. The problem, as succinctly put by the Rochester Business Journal, is that ‘nothing works all the time. The 60/40 allocation doesn’t work all the time, and the alternatives don’t either’. The Journal adds that ‘alternatives are not an easy fix. Even in the worst years in the stock or bond markets there is often some asset class that shines. Tactical adjustments are easy in theory and obvious in hindsight, but they are notoriously difficult to execute in real time.’
So maybe the best option is to stick to the classic 60/40 model of equities and bonds. As the Rochester Business Journal says, ‘A balanced portfolio typically performs well in a booming economy and generally holds up well during recessions.’4 It could be argued that the model came unstuck last year because of the highly unusual economic background, caused by a one-off combination of events. As economies rocketed out of pandemic lockdowns, supply chains could not cope with surging demand and triggered inflation. Russia’s invasion of Ukraine provided a further turbocharge to inflation by driving up commodity prices. The double shock of high inflation and rapidly rising interest rates last year, ‘truly an aberrational occurrence’ according to the Journal, proved a shock that even the tried-and-tested 60/40 model couldn’t withstand in the short run.
1 https://www.marketwatch.com/story/60-40-portfolio-dead-or-alive-11673385267
2 https://www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb
3 https://www.spglobal.com/spdji/en/commentary/article/us-equities-market-attributes/
4 https://rbj.net/2023/06/09/the-death-of-the-60-40-portfolio-revisited-the-informed-investor/
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