Anika Begay
The 60/40 portfolio recently passed its first real test since the bond market crash of 2022, according to Morningstar. During the stock market sell-off in the first week of August, high-quality bonds did what they’re supposed to do: play defense, said Jason Kephart, director of multi-asset ratings at Morningstar. The Morningstar US Market Index, a benchmark for stocks, fell 6.3% from Aug. 1 to Aug. 5, its worst five-day performance since June 2022. Meanwhile, the Morningstar US Core Bond Index rose 1.5% as investors fled to safety. “Inflation has not been the reason we’ve seen this big stock market sell-off,” Kephart said. “When inflation is not the issue, we see bonds behave as they used to.” “It’s been wonderful,” he added. The strategy revolves around a simple balanced portfolio where 60% is allocated to stocks and 40% to fixed income. Traditionally, stocks and bonds move in opposite directions, which helps reduce portfolio volatility. However, in 2022, both stocks and bonds plummeted when the Federal Reserve began raising interest rates to combat inflation. The iShares Core Growth Allocation ETF (AOR) that mimics the 60/40 portfolio fell 17.4% that year. Montagna AOR 1Y The iShares Core Growth Allocation ETF mimics the 60/40 portfolio Since then, the strategy has made a comeback. The 60/40 portfolio has returned 20.5% cumulatively from 2022 through May 2024, according to Vanguard. Even with the 2022 rout, it has an annual return of 6.2% over the past decade, though that has been driven primarily by the outperformance of stocks, said Zachary Rayfield, head of goal-based investing research at Vanguard. The Valley Forge, Pennsylvania-based financial firm now sees a strong decade ahead for a simple 60/40 strategy. “We don’t expect the same level of outperformance on the equity side, but we do expect the bond allocation to play a stronger role, not just in terms of buffering against shocks and downsides, but also in terms of overall portfolio performance,” Rayfield said. What could derail performance is inflation-induced volatility, said Morningstar’s Kephart. Interest rates typically rise when inflation is higher than expected, which pushes bond prices lower, pushing bond yields higher. Stocks typically react negatively to higher borrowing costs. That said, inflation is cooling today. The consumer price index, which measures the price of goods and services, rose 0.2% in July, less than economists had expected. That pushed the 12-month inflation rate to 2.9%. “If inflation continues its current trajectory, you can count on bonds to be that reliable defense again,” Kephart said. Building a 60/40 Portfolio 60/40 is actually another term for a balanced, diversified portfolio, so allocations can change depending on your age and retirement date, as well as your individual needs. Still, it’s a great place to start, Vanguard’s Rayfield said. “60/40 strikes that nice balance,” he said.[It] allows [you] to be flexible to a variety of scenarios, not just market scenarios, but also target timelines.” Within those buckets, investors should be diversified, said certified financial planner Marguerita Cheng, CEO of Blue Ocean Global Wealth. For stocks, she likes to include a range of market caps, from mega-caps to small-caps. In addition to U.S. stocks, she also includes international and sometimes emerging markets, depending on the client’s age and risk tolerance. She also has a mix of growth and value stocks, since they have different cycles. When it comes to fixed income, she also wants diversification in terms of maturity and credit. For high-net-worth clients, Cheng likes to include municipal bonds since they are exempt from federal taxes, as well as state and local taxes if an investor lives in the same jurisdiction as the issuer. She doesn’t look for funds that use leverage or take on too much risk. “If you’re not sure what you should include, you can look for something called total return or strategic income,” Cheng advised. For Morningstar’s Kephart, high-quality bonds are a pretty safe bet right now. Funds that track the Bloomberg Aggregate Bond Index are a good place to look, he said. However, high-yield bonds, also known as junk bonds, have not historically been the best diversifiers, he noted. He would also steer clear of more complicated investments, such as liquid alternative funds. “The 60/40, when people say, ‘It’s broke’ or ‘It’s dead,’ they’re actually trying to sell you something more complex and more expensive,” Kephart said, noting that those complex investments typically don’t lead to better outcomes. “If you want to keep it simple, invest in S&P and Bloomberg Agg. You’ll have a pretty solid portfolio,” he added.
