60/40 Portfolio Allocation is Dead

(Mon, 28 Sept 2020). The conventional approach to investing is dead. Here’s why the 60/40 portfolio allocation no longer works.

Simple and easy to implement, a 60/40 portfolio allocation has worked well in the past 40 years. This investing rule might not work in the coming years as bond yields are very low. Investors should diversify into other assets, such as gold. You’ve probably heard of the 60/40 portfolio allocation as many investment advisers use this investing rule. It consists of allocating 60% of a portfolio to equities and 40% to bonds.

The idea is that this allocation will capture the long-term gains made by stocks while relying on safe fixed-income assets (like government bonds) during short-term stock market downturns.

This Investing Strategy Has Worked Well In The Past

Bonds hedge growth risk, and stocks hedge against inflation. The 60/40 investing rule currently works because the results are negatively correlated. But that correlation could switch soon, which is one reason the allocation might no longer work.

The traditional allocation has performed admirably over the past four to five decades, yielding around 10% per year over that period.

A 60/40 fund would have also helped offset losses this year. Vanguard’s Balanced Index Fund posted a gain of more than 4% since the start of the year. The S&P 500 is down more than 1% over the same period. While this portfolio has worked reasonably well over the past 40 years, the strategy could be running out of steam.

Bond Yields Are Too Low

Currently, the 10-year U.S. Treasury note yield stands at 0.68%. Bond prices move in the opposite direction of yields. Low bond yields are becoming problematic for investors looking for growth. As people are living longer, their retirement will last longer. They need more money to cover higher expenses. Returns on a 60/40 portfolio may not be enough to keep pace with inflation.

Another problem is that the diversification potential of such a portfolio is limited. During periods of market volatility, both bonds and stocks can fall. Income from bonds is no longer high enough to support portfolio during market downturns. JP Morgan says a traditional 60/40 portfolio will offer 3.5% annual returns over the next decade, compared with 10% over the past few decades.

Unless long-term yields turn negative, the ability of bonds to offset declines in the portfolio’s share of risky assets may be limited. If inflation materializes or the Fed hikes rates, investors holding long-term government bonds could suffer painful losses.

Investors Should Diversify Into Other Asset Classes

Investors’ needs change throughout their life. Relying on general investment rules can put them at a disadvantage when they do not consider specific needs, goals, or life stages. Younger investors might prefer to have a more aggressive investment strategy as they are far from retirement. Some of them are 100% invested in stocks, but that’s a risky strategy. A well-diversified portfolio should include more asset classes than just stocks and bonds.

Alternative investments such as hedge funds, real estate, commodities, precious metals, private equity, and inflation-protected assets are new additions to the well-balanced portfolio. A portfolio that includes several asset classes can have a higher return with a lower risk than a traditional portfolio.

Adding gold to a portfolio is a good idea. The investment characteristics of gold are very different from traditional assets like stocks and bonds. Gold tends to outperform during times in which stocks and bonds underperform. The world enters a new era of investing, which may not be favorable to the standard 60/40 portfolio.

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