Simplifying the Investment Strategy Debate
In the world of investing, the 60/40 portfolio has long been hailed as a tried-and-true strategy for achieving a balanced and diversified approach. It typically consists of allocating 60% of the portfolio to stocks and 40% to bonds. However, as the financial landscape evolves and new investment opportunities emerge, questions have arisen about the relevance and effectiveness of this traditional approach. In this blog post, we will explore whether the 60/40 portfolio is still a viable investment strategy in simple terms.
Understanding the 60/40 Portfolio
The 60/40 portfolio is based on the principle that stocks offer higher potential returns but also come with higher volatility and risk, while bonds provide stability and act as a hedge against market downturns. By diversifying across these two asset classes, investors aim to balance risk and reward to achieve steady growth over the long term.
The Changing Investment Landscape
In recent years, several factors have led to debates about the effectiveness of the 60/40 portfolio:
- Low Interest Rates: Prior to 2022, central banks around the world implemented accommodative monetary policies, resulting in historically low interest rates. This diminished the potential returns from bonds, making them less attractive as an investment vehicle.
- Market Volatility: The stock market has experienced increased volatility, driven by geopolitical events, technological advancements, and global economic uncertainties. Traditional asset allocation models may struggle to adequately address these unpredictable market conditions.
- Asset Correlation: Historically, stocks and bonds have exhibited a negative correlation, meaning they tend to move in opposite directions. However, in recent times, this correlation has weakened, reducing the effectiveness of the diversification benefits provided by a 60/40 portfolio.
- Negative Stock and Bond Returns in 2022: Simultaneous declines of stocks and bonds are rare. Since 1931, stocks and bonds were both negative in just one year, 1969, when stocks dropped -8.60% and bonds only -0.74%.1 For most short-term investors, there truly was no place to hide in 2022. The S&P 500 Index declined -18.11% for the year, while the Bloomberg U.S. Aggregate Bond Index fell -13.01% as the Federal Reserve increased interest rates at a rapid-fire pace. The disappearance of fixed income from its customary role as ballast during 2022 made for a particularly challenging year for the 60/40 portfolio, which again prompted the question – is the 60/40 dead?
Alternatives to the 60/40 Portfolio
Given the challenges faced by the 60/40 portfolio, investors have explored alternative investment strategies, including:
- Recalibrate Expectations: Investors will need to face the reality that strong returns enjoyed in recent years may be challenged going forward. For context, in the 10 years preceding 2022, the 60/40 portfolio posted a lofty 11% annual return, despite the low interest rate environment. Comparatively, the long-term levels of around 6% annual return may be a more realistic expectation for the 60/40 portfolio, especially given the potential for higher inflation to reduce real returns.
- Increase Diversification: Rather than relying solely on stocks and bonds, investors are incorporating a broader range of asset classes into their portfolios. This may include real estate, commodities, alternative investments, and even cryptocurrencies. The goal is to capture potential returns from diverse sources and reduce reliance on a single asset class.
- Employ Active Management: Traditional 60/40 portfolios often employ a passive investment approach, tracking broad market indices. However, some investors are turning to actively managed strategies, where investment professionals make tactical decisions based on market conditions. This approach aims to capitalize on opportunities and navigate market volatility more effectively.
While the 60/40 portfolio has been a staple investment strategy for many years, its effectiveness is being questioned in the face of evolving market dynamics. Increased market volatility, changing asset correlations, and expanded access to alternative investments have led investors to explore alternative approaches to achieving their financial goals.
At Tull Financial Group, we focus on the long term where we still see value in a traditional 60/40 approach. Additionally, we embrace opportunities to adapt to the rapidly changing investment landscape and customize to investor preferences. Consulting with a qualified financial advisor before making decisions can help navigate options and tailor a portfolio that aligns with personal risk tolerance, investment goals, and time horizons. Please feel free to give us a call at 757.436.1122 to schedule a complimentary consultation.
IMPORTANT INFORMATION AND DISCLOSURES
Source for return data: YCharts. All returns in reference to the 60/40 portfolio reflect a blend of 60% S&P 500/40% Bloomberg U.S. Aggregate Bond Index. Returns do not reflect the impact of inflation.
The information contained in this article is based on sources believed to be reliable. However, accuracy and completeness cannot be guaranteed.
Past performance does not guarantee future results. As with any investment strategy, there is potential for profit as well as the possibility of loss. Tull Financial Group does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable. This article does not constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. All investments involve risk, including foreign currency exchange rates, political risks, market risks, different methods of accounting and financial reporting, and foreign taxes. Your use of these materials, including the tullfinancial.com website, is your acknowledgment that you have read and understood the full disclaimer.
The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Investments in bonds are subject to interest rate, credit, and inflation risk. Futures trading is speculative in nature and involves substantial risk of loss. Futures are not suitable for all investors.
All investments have certain risks that are borne by the investor. Tull Financial Group’s investment approach keeps the risk of loss in mind. However, as with all investments, clients face investment risks with particular instruments discussed in this article.
RISKS OF ASSET CLASSES DISCUSSED IN THIS ARTICLE
Important considerations regarding liquid alternative funds
- Fund performances vary. The strategy of any liquid alternative fund is set by the portfolio managers, and the performance of individual funds varies widely. Research your fund options and understand the strategy behind them before you invest in any one.
- Personal risk tolerance.Because these funds can include short positions, use of derivatives, and illiquidity, there’s the potential for significant losses. Establish your own risk tolerance and then invest accordingly.
- Investment goals. Talk to your financial advisor about your goals, and whether a liquid alternative fund makes sense for your return expectations and overall investment strategy.
Real Assets: Investments in infrastructure-related companies have greater exposure to adverse economic, financial, regulatory, and political risks including government regulations. Global securities may be significantly affected by political or economic conditions and regulatory requirements in a particular country. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks. Investments in international markets can involve risks of currency fluctuation, political and economic instability, different accounting standards, and foreign taxation.
Bonds: With fixed income securities, such as bonds, interest rates and bond prices tend to move in opposite directions. When interest rates fall, bond prices typically rise and conversely when interest rates rise, bond prices typically fall. When interest rates are at low levels, there is a risk that a sustained rise in interest rates may cause losses to the price of bonds. Bond investors should carefully consider these risks such as interest rate, credit, repurchase and reverse repurchase transaction risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to sub-prime mortgages. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.
Commodities may have greater volatility than traditional securities. The value of commodities may be affected by changes in overall market movements, changes in interest rates or sectors affecting a particular industry or commodity, and international economic, political and regulatory developments.
Large capitalization (large cap) investments involve stocks of companies generally having a market capitalization of $10-$200 billion. The value of securities will rise and fall in response to the activities of the company that issued them, general market conditions and/or economic conditions. Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market.
Cryptocurrency is a digital representation of a stored value secured through cryptography. Although Bitcoin might be one of the most widely known cryptocurrencies today, there are many others. The markets for cryptocurrencies remain highly volatile and risky. Before turning your hard-earned cash into crypto, review investor alerts and other resources from regulatory authorities.
S&P 500® Index: A free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the U.S. Stocks included in the S&P 500® are those of large publicly held companies that trade on either of the two largest American stock market exchanges: the New York Stock Exchange and the NASDAQ.
Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities (specifically, Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).