Here’s Why The 60/40 Portfolio Died

The "60/40 portfolio" experienced its worst year since 1926 in 2022.

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Yet, the conventional investing strategy, in which investors place 60% of their capital in stocks and 40% in bonds, has, at least thus far, enjoyed a significant recovery in 2023.

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According to Bank of America, such portfolios saw a 6.2% gain in January, ranking 96th out of all months since 1921.

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The gain, which made up for losses from December, was slightly below the S&P 500's 6.3% total return for the same period.

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However, Jim Caron of Morgan Stanley is skeptical by the rally and declares the 60/40 strategy to be "a thing of the past."

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Not any longer a solid hedge?

The primary goal of the 60/40 portfolio, according to the co-chief investment officer of global balanced funds at Morgan Stanley Investment Management, was to create a profile that would allow an investor to compound profits over time in a predictable way.

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And that strategy has previously been successful for investors, as seen by the fact that bond returns have been positive for 36 of the last 40 years, according to Caron.

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"Yet from 1980 to 2021, interest rates were declining at that time. The idea that a 60/40 balance in a portfolio will produce stable returns over time like it did over the past 40 years, however, is actually missing the point if interest rates simply move sideways or even slightly higher, according to Caron.

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To balance risks and provide more steady returns, one must consider various and dynamic components of bonds and stocks, according to Caron.

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Because of this, he continued, the 60/40 plan may no longer be the best course of action for investors.

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Jared Woodard, a strategist at Bank of America, holds the same opinion. He said in a Feb. 13 note that the reasoning behind maintaining a 60/40 portfolio over the long haul "appears flawed."

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The reversal of globalization, the emergence of ESG regulations, the inflationary demographics, and the worn-out tech disruption appear to be signaling the end of the deflationary climate of recent decades. Inflation and interest rates will be structurally higher as we move from a world with an average fed funds rate of 2% to one with a rate of 5%, he said.

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That suggests that the time when bonds served as a trustworthy hedge appears to be over, with stock and bonds now enjoying a positive connection, he continued. Bond and stock returns have historically had a negative correlation; as one rises, the other falls. This lowers portfolio risks and restricts losses during times of market turbulence.

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How Should Investors Behave?

Caron has some reservations about the 60/40 investment approach, but he thinks investors now have a "wonderful chance" with fixed income.

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Bond yields have increased once more. At this point, it almost feels like we're given a second chance. Our high yield [bond] yields are close to 9%. Generally speaking, developing market yields are roughly 8.75%. Investment-grade yields are also around 5%, he added.

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That's "pretty excellent news," according to Caron, for investors wishing to invest in or rebalance into fixed income.

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On the assumption that the Federal Reserve will maintain higher interest rates for a longer period of time, yields on US government debt have been skyrocketing. On Tuesday, the yield on the standard 10-year Treasury reached a high of 3.983%. The 2-year yield also reached its highest level since November a day earlier, on Monday.

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Regarding stocks, Carson noted that the recent decline following a great start to the year offers investors short-term chances. 

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