The 60/40 rule of thumb for investing has been killed and revived many times over the years.
Now that stocks (the 60’s) and fixed income (the 40’s) are both declining, this strategy is once again being called into question. Calls are growing for a more accurate weighting of portfolios, including alternative investments such as real estate investment trusts (REITs) or even old-school certificates of deposit due to higher interest rates (CD’s).
Minneapolis-based investment research firm The Leuthold Group took a deep dive this October into asset allocation, both historically and forward-looking. They didn’t definitely get on the 60/40 side, but they argue that it continues to show its worth for long-term investments.
True, research lead Scott Opsal writes in the report that “the 60/40 strategy is having a terrible 2022.” The results are evident in the first chart below, which shows the annual returns of a 60/40 mix of stocks and bonds, with both falling sharply this year.
Source: The Leuthold Group
Despite this, the chart shows that despite a bad year, the 60/40 strategy has worked fairly well over time.
“Since 1976, there have been nine years in which the 60/40 portfolio has posted negative returns,” writes Opsal. “Three of those years were barely negative and three more stopped short of a 5% overall loss. The only two annual declines of more than 5% occurred in 2002 and 2008 in the depths of severe stock bear markets, and in both cases bonds provided positive returns to mitigate the overall loss.”
Then came this year when the values of both together fell significantly.
So the question is how to tell if this is an outlier in an otherwise good strategy or a turning point. To get an answer, Opsal analyzed the “expected” returns for 60/40 investments over time. He then adjusted this to annual performance.
He found that realized returns on stocks and bonds “quite often in recent years have been significantly above expected returns, as indicated by bars rising higher than the green line.”
Source: The Leuthold Group
Through the research, Opsal estimates that rising valuations “have pushed actual annualized returns nearly 3% above expected returns since the end of the tech crash of 2002 through 2021.” Even with this year’s decline, the excess return over expected returns over the last 20 years is 1.5% annualized.
Going forward, returns could be even better, according to Opsal. Current falling stock valuations and rising bond yields have pushed estimated yields to 6.9% in a 60/40 mix, which “has significantly improved the attractiveness of 60/40 going forward.”
However, the company also notes that stocks and bonds tend to have the same sensitivity to inflation and interest rates, and have opposite sensitivities to economic growth and unemployment. In short, “when inflation and interest rates dominate the conversation [today]should we expect a positive sign for correlation” or a higher risk of market declines.
When a situation like the current one recurs, “investors may be less willing to hold large allocations to stocks if they are feeling bearish,” writes Opsal.
The rise of Target Date Funds (TDFs), an age-based investment that generally allows for greater risk when a saver is younger and becomes more conservative over time, shows that many people know that the 60/40 mix isn’t One size is all. TDFs have grown in popularity in recent years, particularly among younger 401(k) participants, according to May research from the Investment Company Institute (ICI) and the Employee Benefit Research Institute (EBRI).
Many are also using this moment to highlight the need for alternative investments in portfolios, and research shows that financial advisors are taking note.
Milind Mehere, founder and CEO of New York-based Yieldstreet, a digital alternative investing platform, says it’s the natural evolution of investing.
He argues that institutional investors have already switched to alternative investment strategies and the general public should now have access to them.
“What we’re really saying to our investors is that you need to start modernizing your portfolio away from 60/40,” says Mehere. “Institutional investors are more than 50% committed to alternatives, but retail investors are only 5% invested in them. We need to start moving from 60/40 to 50/30/20 or something like that.”
The Leuthold Group researchers note in their report that, as with most investment decisions, timing matters.
2022 proved that “commentators were rightly skeptical about the future prospects of the strategy,” writes Opsal. “However, after a record correction this year, the 60/40 is again valued to deliver reasonable expected returns, albeit with more volatility caused by less benefit from diversification.”