The investment portfolio cocktail of 60% equities and 40% bonds has many critics — big financial institutions have lined up to sneer at the mix for over a decade now.
Investors have been urged to look at more exotic options to generate gains amid questions over the outlook for returns from bonds. Yet over the last 14 years, you would have done better by holding a 60/40 portfolio than following some other hyped-up strategies.
Skepticism about the value of 60/40 portfolios hasn’t abated though, and now the concerns are about more than just the low returns from government bonds.
The key principle underpinning the 60/40 strategy is that the smaller fixed-income allocation should cushion losses when stocks slump. Yet during a bout of market volatility in March, both equities and bonds sold off at the same time.
If both asset classes were to start moving in tandem regularly, that would call into question the whole point of holding lower-returning bonds as a hedge.
So what can retail investors do?
Don’t panic
While the worries are all valid, they don’t mean a 60/40 asset split has suddenly become financial suicide overnight.
“60/40 is not a bad place to start,” said Christine Benz, head of personal finance at Morningstar. “The idea it’s dead is a straw man investment firms sometimes throw out there because they are peddling other strategies, oftentimes more complicated, oftentimes more costly.”
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If you want to go the DIY route, be clear on your objectives.
There’s a huge difference in an appropriate allocation for someone looking to retire in 30 years, versus someone looking for returns five years out.
Even during the time when 60/40s were in vogue, advisors wouldn’t have suggested someone on the brink of retirement allocate the majority of their money to volatile equities. Equally, a 20-year-old would have been told to allocate more to growth assets.
And remember, balanced portfolios are never designed to deliver the maximum possible level of return. You’re probably not going to get the type of market-trouncing returns Cathie Wood’s growth-focused ARK funds notched up in 2020.
Rather, the idea is to preserve capital, provide diversification and protection in bad times, as well as an acceptable return.
Be realistic about those returns
In a world where 85% of developed-market government bonds are yielding below 1%, likely returns from a traditional mix have plunged. While Vanguard
Bond yields have started to rise again, meaning it’s a better jumping off point than it was for new investors, but with interest rates at record lows across advanced economies, high returns on safe assets are something of the past.
That’s true even for the pros. Hedge funds have increasingly moved into more and more
“There aren’t a lot of mispriced cheap assets out there,” said Simon Doyle, head of fixed income and multi-asset strategies at Schroders Australia.
Don’t assume the answer is just more tech stocks
As bond returns have plunged, many retail investors have upped their allocation in stocks, lured by the potential for higher growth. While over the long term equities have historically outperformed bonds, that’s not always the case — following the tech bust in 2000, equity indices essentially went sideways for a decade.
Additionally, short-term volatility is typically more extreme in equities than in fixed income. That means you need discipline to avoid making the classic mistake of selling in a panic, but also be realistic about your time horizon. Holding pat might be fine for someone in their 20s or 30s who has many years to ride out any slumps, but far more problematic for someone looking to retire in a shorter time frame.
One option is to make sure you aren’t just holding stocks purely for expected share price growth.
Due to declining returns from bonds, the model 60/40 portfolio may eke out real returns of just 1%-2% a year over the next decade, said Lim Chow Kiat, chief executive officer of GIC.
Mark Luschini, chief investment strategist at Janney Montgomery Scott, says he’s seen a trend of clients incorporating more dividend-paying stocks into their portfolios to make up for the income that’s lacking from high-quality fixed income.
“Select companies whose dividend policy has been supported by the quality of their balance sheet as well as management’s commitment to sustain or raise it regularly,” Luschini said.
Don’t go for plain vanilla
“Owning defensive assets like government bonds still makes a lot of sense,” said Anthony Doyle, a cross-asset investment specialist at Fidelity International. “But only in order for you to take more risks in other parts of your portfolio.”
In its original iteration, 60/40 investors would only hold U.S. Treasurys in their fixed income portion. Those days are long gone. Nowadays, via either managed funds or ETFs, retail investors can access a much wider range of credit, both corporate and sovereign.
“Fixed interest allocations of portfolios should be diversified in their own right,” Martin Hennecke, Asia investment director at wealth manager St. James’s Place said. And that doesn’t just mean different sectors or geographies. Hennecke also warns investors against owning too many long dated bonds, which may sell off in the event a rise in inflation triggers higher interest rates.
If keeping pace with inflation is your concern, you can also consider
At Schroders, Doyle says he’s been focusing on building out assets that sit somewhere between equities and bonds.
That means upping the allocation to things like corporate credit, emerging market debt, private loans and commercial real estate lending. “These are things which aren't as risky as equities but certainly have a bit more risk in them than say a sovereign bond,” Doyle said.
Stuart Fechner, director of research relationships at Australian fund manager Bennelong, also points to newer assets like global listed real estate and infrastructure as ways to get some more diversity into retail portfolios.
Whether cryptocurrencies like Bitcoin or Ether can — or should — be part of a balanced portfolio is a hotly contested subject. Proponents argue it’s uncorrelated to other assets, and so can offer a good hedge.
Skeptics liken it to gambling and warn investors they could be wiped out. The middle road, which is increasingly being advocated by Wall Street strategists, is to explore a small allocation, which wouldn’t take too much of a hit even if crypto prices go down substantially.
An allocation of 1% could boost risk-adjusted returns without taking on too much exposure, JPMorgan Chase strategists said in a
If you need a hand, there are half-way houses
Many professionally managed 60/40 funds operate based on ranges, allowing the portfolio manager to tweak allocations compared to the risks and opportunities they see at the time.
If you aren’t up for taking on that rebalancing task yourself, yet are nervous about high fees, there are alternatives.
Over the past year, the 20 mutual funds in this ranking have an average gain of more than 100%. Their fees are also more than twice the broader industry.
Morningstar’s Benz suggests that for those who want set-it-and-forget-it simplicity, a good first option is a target date fund where a professional manages asset allocation to deliver returns by a predefined end date. While it’s typically a bit more expensive than a straight index fund, they’re normally cheaper than more active options.
There also is a growing band of digital start-ups that aim to give you a smoother ride. One of those, StashAway, which has about $1 billion in assets under management, rebalances its clients portfolio based on economic conditions and their risk profile.
“60/40 is a fine place to start, but it doesn’t give you consistent risk over time,” said Stephanie Leung, an ex-trader at Goldman Sachs who now runs StashAway’s Hong Kong operation.
