The bellweather 60/40 portfolio, (60% stocks/40% bonds), has been around for decades and has been praised by many experts as a reliable and effective way to grow your money over the long term.
But in recent years, the 60/40 portfolio has faced a lot of criticism and skepticism. Some say it’s outdated, inefficient, and doomed to fail in a low interest rate environment. They argue that bonds offer little diversification benefits and that stocks are too volatile and unpredictable.
However, people should know that the 60/40 portfolio isn’t dead. In fact, it could be argued that it is better positioned now than it has been for many years. Stocks have been more volatile than they have been in recent years. And unfortunately, bonds have not offered much support lately. However with the massive move upwards in interest rates, the 60/40 is well positioned going forward.
What’s Up With Low Interest Rates?
After the 2008 financial crisis, a lot of investors got used to ridiculously low interest rates. They assumed rates would be lower forever, or at least for longer. And for years that held true. In their fight against inflation, The Federal Reserve (aka the Fed) started raising rates in March of 2022 and has not looked back. In fact the Fed has raised the federal funds rate 11 times since they started. These higher rates make high quality bonds look much more attractive for many investors.
One of the best indicators of how bonds will perform is starting yields. For example, if the yield for a 10-year Treasury is 1.5%, that’s not too exciting. But, if it’s hypothetically yielding 3% or 4%, that’s much better. Additionally, if stocks sell off that money often flows into bonds, thereby driving up bond prices. Even if stocks don’t decline, higher yields in bonds means you can still receive a decent return in this situation.
2022 was rough for investors across the board. The U.S. bond market dropped by about 13%, and the S&P 500 fell around 19%. The tech heavy Nasdaq fared even worse as it dropped by about 33% from its 2021 closing value. This is the first time since 1974 that both the major stock and bond indices have declined by more than 10%. But there’s some good news in a murky situation. While the bond market is negative for the year, it has recently bounced off of its lows as the 10 year treasury yield has come down in recent weeks.
Despite a recent pullback, the S&P has had solid gains since the last Fed meeting.
A Look at Alternatives
Alternative investments have been at the forefront of the investment discussion for a while. Many investors and advisors thought them to be a sort of “perfect” investment offering equity-like returns with bond-like risks. However as interest rates rise and bonds become a more attractive diversification option, I don’t see a strong case for most alternative investments.
Alternative investments are often expensive. Many have internal expenses of more than 2%. As a CERTIFIED FINANCIAL PLANNER™ professional who provides investment guidance to clients, I’m fine with higher costs if the value is there. However with alternatives this has unfortunately proven to historically not be the case.
In my experience, simplicity and sticking to fundamentals are usually best when it comes to investing.
However, alternatives often involve a great deal of complexity.
Finally, alternatives sound great in theory, but they have not always performed as hoped when exposed to reality.
The Good Thing About Bonds
As we said earlier, starting yields are one of the best predictors for how bonds will perform. One of the biggest risks to bonds is rising interest rates. When rates are already high, there’s an opportunity for the rates to come down. This causes bond prices to move higher. Think of it as a teeter totter with interest rates on one side and bond prices on the other.
Additionally, because they are higher in the capital structure for bankruptcies, bonds have inherently less risk than stocks, assuming they’re held to maturity. Some bonds, like US Treasuries are actually considered risk free because they’re backed by the full faith and credit of the United States government.
Bonds can be a good investment when interest rates are high, because you’re getting paid more to wait. When interest rates come down, the bond prices will go up. Assuming the credit quality is good, you’ll still be holding a bond that’s paying a nice coupon.
The Bottom Line
The 60/40 portfolio isn’t dead by any means. In fact, with rates where they’re at, the 60/40 is set up better than it has been for a long time. With higher interest rates, it is reasonable for investors to expect bonds to lower the overall volatility in their diversified portfolio while at the same time offering higher expected returns.
Backwards-looking investing is no longer enough in the world of higher interest rates.
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The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
No strategy assures success or protects against loss.
All investing includes risks, including fluctuating prices and loss of principal.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Good Life Advisors, LLC, a registered investment advisor. Good Life Financial Advisors of NOVA and Good Life Advisors, LLC, are separate entities from LPL Financial.