Is the 60/40 Portfolio Dead?
Portfolios with 60% stocks and 40% bonds have been a staple of investing for the last few decades, but many think these portfolios could face major challenges in the next several years. With interest rates near historic lows, successful bond investing could look much different in the future.
The 60/40 portfolio has been a common strategy for investors, especially those near retirement, for many years. The mix of 60% stocks and 40% bonds has helped deliver a less volatile investment experience over the last few decades while also delivering solid returns. In fact, according to Michael Batnick, director of research at Ritholtz Wealth Management, a 60/40 portfolio has posted an average return of 10.7% over the past 50 years.
So, why is the 60/40 portfolio now coming under fire? In short, the answer is interest rates.
Part of the reason that average returns have been so high over the last 50 years is because of the strong performance of bonds over that time. However, some think that strong bond performance is a thing of the past. To understand why, we first need to understand the relationship between bonds and interest rates.
Bond Market vs. Stock Market
Bonds and stocks are entirely different. Stock values increase or decrease as a product of what happens in the stock market. Similarly, bond values increase or decrease as a product of what happens in the bond market. Although the two markets could always have some underlying effect on each other, they still act as two separate markets.
Bond markets are tied directly to interest rates. When interest rates (or bond yields) go down, bond prices go up. When interest rates go up, bond prices go down. That inverse relationship has been a major driver of the impressive bond performance over the last 40 years.
According to Macrotrends.net, the 10-year treasury note reached an all-time high of 15.84% in 1981 and has been trickling consistently downward ever since. As of February 26, 2021, the 10-year treasury is hovering around 1.48% (according to Yahoo Finance). The decline in interest rates over that time period has resulted in average bond returns of 7.67% from 1980-2018 (according to TheBalance.com).
Why Bonds Could Struggle in the Future
While bonds enjoyed the decline in rates over the last 40 years, the future could look much different. With rates being so low already, some wonder if they can even go much lower, although that has been the case for a few years now. However, in August of 2020, the 10-year Treasury Note surprised some of us when it hit an intra-year low of approximately 0.51%.
The message from some bond managers is that although rates could go slightly lower, there isn’t much room for them to fall further. Therefore, we are likely to see either a leveling or interest rates or a slight climb in the years to come. This could cause certain types of bonds to suffer, especially those that are more interest-rate sensitive, which means a potential for low or negative bond returns.
How Can Investors Address Interest Rate Concerns?
While the concern over interest rate risk is certainly valid, we aren’t ready to declare the 60/40 portfolio is dead. There are a few ways to overcome these challenges and manage your exposure to interest rate risk.
1) Be Active to Avoid Some of the Increase in Rates
Interest rates rise and fall just like stocks. They don’t tend to move as drastically or as quickly, but they still move. An active approach to bond management could lead to improved returns by taking action on bonds at the right time vs. simply sitting in a bond index fund (and perhaps catching 100% of the rise in interest rates).
2) Lower the Duration of Your Bonds
Not all bonds have equal sensitivity to rises in interest rates. The level of interest rate sensitivity that a bond has is measured by something called duration. The higher the duration, the more sensitive the bond or bond fund is to changes in interest rates. If interest rate risk is a concern, you might consider choosing bonds or bond funds that are less interest rate sensitive, or bonds that have a lower duration.
3) Use a Diversified Bond Approach
While everything mentioned in this article generally captures a summary of the bond story over the last 40 years, it certainly does not explain everything. Different bond sectors, not surprisingly, have different risk and return characteristics. While interest rate risk is higher in treasury bonds, that is not necessarily the case across the board.
Bonds can differ based on their term, credit quality, geographic region, economic focus, etc, and each sector could offer attractive opportunities at various times. A knowledgeable bond manager can help identify sectors that best match your objectives as a bond investor.
Is the 60/40 portfolio dead? Not at all. Many people continue to invest with a 60/40 mix between stocks and bonds, and it’s likely that many will continue to do so. However, while 60/40 investing might continue, it’s important to note that the expectations from investing in this manner should certainly change.
Bond returns are expected to be lower and thus, a successful 60/40 average return will likely be lower in the future. Also, the methods to receive a “successful” 60/40 average return will look different due to our extremely low interest-rate environment.
Investing, especially near retirement, is not a time to play with fire. If you are unsure how you should be invested, consider getting advice from a retirement investment specialist. Because although many investors and advisors do not pay much attention to the bond portion of the portfolio, bonds still hold a significant place in long-term retirement investing. For more on, “Is the 60/40 Portfolio Dead,” click here to watch this edition of The Retirement Power Hour, CarsonAllaria’s monthly webcast, hosted by Partner and Wealth Advisor, Joe Allaria.
1. TD Ameritrade: https://tickertape.tdameritrade.com/investing/60-40-portfolio-rule-18263#
2. MacroTrends.net; https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart
3. The Balance.com; https://www.thebalance.com/stocks-and-bonds-calendar-year-performance-417028
4. Yahoo Finance; https://finance.yahoo.com/quote/%5ETNX?p=^TNX&.tsrc=fin-srch
Joe Allaria, CFP®As featured in The Wall Street Journal, USAToday.com, CNBC.com, Nasdaq.com, and Yahoo Finance.
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