This is article is a guide to the 60-40 portfolio.
- What is a 60-40 portfolio?
- How does a 60-40 portfolio work?
- What are the returns?
- What are the pros and cons?
- How do you build one?
What is a 60-40 portfolio?
The 60-40 portfolio is an investment strategy where the investments are made up of 60% stocks and 40% bonds. It is often referred to as a balanced portfolio.
It has been one of the most common investment strategies over the last 40 years and is the default portfolio used by many financial advisors and investors.
How does a 60-40 portfolio work?
Investing in stocks is risky as they are volatile and can suffer large ups and downs. Over the last 22 years there have been drops of 37%, 32%, 52%, 28% and 34%.
Having 100% of your investments in stocks leaves your portfolio at risk of taking some heavy losses.
However, bonds are relatively low risk and generally protect your money from big losses. Bonds also provide a yield which provides the portfolio with a steady and regular income.
The theory is that two asset classes are uncorrelated; if stocks go down the bonds will go up. This helps reduce the negative impact on your investments when the stock market crashes.
But why the 60-40 split? Historically stocks have provided greater returns than bonds. So, balancing 60% of a portfolio towards stocks will allow a portfolio to benefit from the increased returns stocks provide. The 40% in bonds provides a safety hedge and a yield to support the portfolio when stocks are struggling.
There are different portfolio splits according to your risk tolerance and investment life cycle but the 60-40 provides a good balance between growth and protection.
What are the returns of a 60-40 portfolio?
Since 1988 the 60-40 portfolio has returned 7.5%. The portfolio outperformed a 100% stock investment in the MSCI World Index (cover the large and mid-cap companies in the 23 developed countries)
As you can see from the graph below the returns have been much smoother and less volatile in the 60-40 portfolio than the peaks and troughs of an all stock portfolio. It has also outperformed a 100% bond based portfolio.
The advantages of the 60-40 portfolio
The mix of assets helps reduce the volatility and protect the portfolio against large losses which can be emotionally and financially painful, especially if you are close to a time when you need to access your investments.
The balanced portfolio ensures a disciplined approach to investing and promotes successful investment behaviour. By regularly rebalancing the investments to keep the 60-40 mix you automatically sell at the highs and buy at the lows.
For example, if stocks have gone up and represent 70% of the portfolio you will sell the 10% crystallising profits. When markets go down the bond percentage of the portfolio is higher you will sell bonds and buy more shares when they are low. It helps you to avoid the biggest mistake of panicking and selling when the market is going down.
The disadvantage of a 60-40 portfolio
The portfolio does not stop losses or negative periods. 60% of the portfolio is invested stocks which are the high risk assets. If stocks drop by 50% the stocks part of the portfolio will still go down by to 30%. The 40% bonds may provide some upside, but your investments will still take a considerable knock.
Stocks and bonds are not always uncorrelated. With globalisation, low interest rates and modern central bank monetary policy assets have become more correlated and so bonds can sometimes move down with stocks. At these times, the bonds will not be an effective hedge as expected.
The 60-40 portfolio does not diversify the portfolio with real assets such as cash, property, commodities, gold, or cryptocurrencies which can be beneficial to an investment strategy especially in times of rising inflation.
How do you build a 60-40 portfolio?
Most investment platform offer 60-40 ready-made portfolios. A professional investor has already chosen the assets and will rebalance the portfolio regularly. This is the best way for new investors to start investing in a 60-40 portfolio.
Some investors build their own using just index funds or etfs.
Others pick their own individual assets, but this takes a lot of time, knowledge, and experience.
If you are unsure or need further assistance, contact a financial advisor.
60-40 portfolio summary
The 60-40 portfolio has worked very well for the last 40 years. The portfolio has provided good returns and at the same time reduced the volatility of investing compared to an all shares portfolio.
It creates a disciplined approach to investing ensuring investors avoid the biggest mistake of selling low and actively helps investors to buy low and sell high.
However, historical performance is no guarantee of future success. Currently, bonds are expensive, and yields are extremely low, or negative; combined with increasing inflation this portfolio may prove to be less successful in the future.
Some investors are adapting the original 60-40 portfolio to include other assets to protect against inflation and low bond returns.
The 60-40 portfolio can be a good starting point for many investors.
As with all investments make sure you have worked out your investment goals, time horizon and attitude to risk to find the right portfolio for you. If in doubt seek financial advice.