The 60/40 portfolio has long been viewed as a win-win for investors. Conventional wisdom advocates a model portfolio holding a mix of 60% stocks and 40% bonds. This has historically delivered solid returns with moderate volatility, allowing investors to sleep well at night.
While the 60/40 can benefit any type of investor, it is especially appealing to those nearing retirement. At that point, focus often shifts from a “swinging for the fences” investment mentality to one of capital preservation and income generation. The biggest fear many retires have is a bear market hitting just when they need to start drawing funds out of the portfolio. Not only do they need the supplemental income, but there is less time for their portfolio to recoup losses. Instead of a restful night, this is the stuff of nightmares. To address this fear, the 60/40 bundles the long-term growth of the stock component with the income stream and lower volatility of the bond holdings.
The standard 60/40 might invest the stock component in the S&P 500 or U.S. Total Stock Market Index, and the bond component in the Barclays US Bond Aggregate. It can also be done through the purchase of individual stocks and bonds, both domestic and international holdings. Investors have turned to mutual fund companies to do the work for them, and the Vanguard Balanced Index Fund (VBINX/VBIAX) is one of the largest examples. This fund will remain within 1% of its target ratios.
How Has the Strategy Performed?
Performance for the 60/40 has been solid. Over the recent 3-year period, ending 6/30/20, the Vanguard Balanced Fund has returned 8.58% annually with a 10- year return of 9.94%. During the same time periods, the S&P 500, returned 10.57% and 13.84% respectively. Bonds also performed well, with the Barclay’s Agg returning 5.27% over the past 3 years and 3.7% over 10 years. The downward spiral in interest rates and subsequent rise in bond prices has been unprecedented and resulted in a bond market bull market.
Looking ahead, if retirees could expect a 10% annual return going forward coupled with moderate risk, most would be dancing all the way to the bank. However, there are reasons to believe this may not be the case.
What is the Current Prognosis?
The argument today is that the 60/40 has lost its appeal due to historically low bond yields and reduced expectations for equity returns. Current low interest rates imply bond prices are already high, with little room to appreciate unless we move into negative interest rate territory. This makes bond price moves less effective in countering a plunge in equity prices.
In addition, despite the correction in March, equity markets were coming off the longest bull market in history. Market gurus have also expressed skepticism that equities will deliver the same historic returns going forward.
Many are predicting the 60/40 is “dead” and investors should expect lackluster future performance. As a result, Morgan Stanley is forecasting just a 2.8% average annual return over the next 10 years for the 60/40. Professor Jeremy Siegel, the Wharton and Wall Street guru, weighs in with a 4.6% return.
Interest rates - The 10-year treasury is now at 0.58%, the 30-year at 1.28% and 30-year mortgage borrowing rate at a historic low of under 3%. The overwhelming federal response to the COVID-19 crisis saw the Federal Reserve pushing interest rates lower to take the pressure off the struggling economy. Rates can hover at this level for some time, but with little room on the downside, the probability for higher rates, and lower bond prices has increased. This will dampen fixed income returns going forward. Morgan Stanley is projecting a 2.1% rate of return for bonds and Professor Siegel a 2% return.
Equity returns -U.S. equities are coming off a fabulous bull market, with a 10-year return of almost 14%. While it is difficult to predict the future, that hasn’t stopped market pundits from trying. Morgan Stanley is projecting a 4.9% rate of return for equity, Professor Siegel 6% and Vanguard between 4% and 6% over the next decade.
Inflation - Inflation has not been an issue for the past few years. However, in the post COVID- 19 world that may not continue. In addition to the Federal Reserve injecting liquidity into the system, the Federal stimulus package of $3 trillion is a bill that will someday need to be repaid. Inflation may rear its ugly head, subsequently eating away at investment returns.
What are the Options Going Forward?
Investors need to look at their risk tolerance and decide if increasing equity exposure is worth the incremental return. There is a reason bonds are in a portfolio, and it has to do with tempering volatility. Remember, many people prefer to sleep well at night. Some other options include:
Substitute for the Traditional Domestic Stocks and Bonds. The yield on the S&P 500 has recently been greater than the yield on the 10-year treasury. One option is to substitute high quality dividend-paying stocks for a portion of the bond holdings. You can also look at sectors that haven’t performed as well to fill the equity side, including value stocks, international and emerging markets. Some investors add different asset classes such as gold, private equity and real estate. These changes provide some variation to the traditional 60/40.
Increase Your Equity Allocation. 75/25 may be the new 60/40. People are living longer and need their money to work harder for them. Projected diminishing returns for stocks and bonds over the next decade may cause you to revisit your asset allocation. If you are comfortable, a 70-80% exposure to equities may improve projected returns.
Expect Lower Returns – which is OK. The 60/40 portfolio was designed to offset equity risk. We are in an unprecedented time, and what markets do post COVID-19 remains to be seen. Volatility in financial markets may increase, in which case it may be advisable to stick with the tried and true 60/40 for a bit. Investors must make a personal decision; if reaching for incremental returns takes away their peaceful nights, they may wish to revert to a good night’s sleep.
Note: Elaine Phipps, MBA, CFA, is a Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.
Point View Wealth Management is an SEC-registered investment adviser and part of Peapack Private Wealth Management. For over 25 years, Point View Wealth Management has been providing customized portfolio management services and comprehensive financial planning solutions for individuals and their families to develop and achieve their financial goals.
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