Should you stick to the traditional 60% to 40% rule of thumb?
Hedging equity exposure with bond investments did not work as hoped last year. The S&P 500 fell 19.4% and instead of moving in the opposite direction in response to a flight to safety, the ICE BofA index of the US bond market fell 3.8%.
However, due to the bond bear market, the yield on benchmark ten-year U.S. Treasury bonds more than tripled, from 1.50% at the start of 2022 to 4.65% as of November 9, 2023. Some commentators now suggest that a traditional 60/40 portfolio (representing the respective percentage weightings of the two categories) is a good strategy for the future. Maybe, but there’s no guarantee you won’t be disappointed.
Historical experience can be a useful guide in managing one’s expectations of what any investment strategy can deliver. In the case of 60/40, it is instructive to examine how it performed the last time rates were around their current level. Every year between 2004 and 2008, the ten-year Treasury yield began the year in a range of 4.0% to 5.0%. The chart below summarizes the performance of the stock-only, bond-only, and 60/40 portfolios over the five-year period.
*S&P 500 **ICE BofA US Bond Market Index
The 60/40 mix’s average annual return of 1.84% for the period is significantly better than the pure stock portfolio (0.03%), barely positive, but not very exciting in absolute terms. Equally uninspiring is the figure of $0.93 at which $1.00 invested at the start of the period in the 60/40 mix “increased” by the end of 2008. This was only slightly better than the figure for $0.90 for shares.
Fans of the 60/40 mix can certainly argue that the time period depicted was unusual. The last year, 2008, represented the first 12 months of the Great Recession, the worst U.S. economic downturn since the Great Depression of the 1930s, by various measures. Therefore, the five-year average return reflects the S&P 500’s horrendous -37.00% return from 2008. The chart’s best advertisement for the 60/40 approach is its significantly less horrendous -20.38% return. this year.
Over the next five years, a 60/40 split could very well provide much greater benefits than during the five-year period when interest rates were closest to today’s. Furthermore, the strategy could be better in ten years than in just five years.
This possibility underlines a key point in assessing the suitability, for your particular needs, of a classically balanced portfolio: much will depend on the duration over which you rely on the strategy to produce an acceptable compromise between maximizing return and limiting intermediate market fluctuations. value of your assets.
Also keep in mind that a 60/40 split is no more a one-size-fits-all solution than any other asset allocation approach. According to one school of thought, the right weighting of stocks and bonds depends on your age. The idea is that you should reduce your equity percentage as you approach retirement, to minimize the risk of retiring with too small a nest egg due to a sharp decline in the stock market just as you reach this point.
This life cycle concept is typically implemented by subtracting your age from 100 to calculate your appropriate stock allocation percentage. This is also not the right answer for everyone. Let’s say you’re fortunate enough to be able to expect to have sufficient retirement income without having to shift more of your portfolio from stocks to bonds, which provide higher current income. In this case, the appropriate asset allocation may depend more on the age of those who will inherit your assets.
In conclusion, a 60/40 portfolio can meet your needs and can perform very well from there, both in the short and long term. However, these are more difficult questions than they seem. The answers depend on individual circumstances and the non-uniform behavior of stocks and bonds over time.
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