INVESTING EXPLAINED: What you need to know about 60/40 – the “perfect” investment portfolio split of 60% stocks and 40% bonds
In this series, we break the jargon and explain a popular investing term or topic. Here it is 60/40.
What is this?
For more than 50 years, it has been believed that the ideal investment portfolio consists of 60% stocks and 40% bonds.
This standard allocation model was deemed ideal for individuals, pension funds and other institutions that wanted diversification and some volatility protection. Some have argued for a 50/50 split, but the 60/40 model has gained traction.
Who thought that?
American economist Harry Markowitz devised the strategy in 1952 as part of his famous “modern portfolio” theory.
It is said that the 96-year-old Nobel laureate did not expect his idea to be taken as gospel and may not have applied the principle to his own money, but it is not certain that these statements are valid. For more information, visit hmarkowitz.com.
Allocation: For over 50 years, it has been believed that the ideal investment portfolio is 60% stocks and 40% bonds.
What is the reason behind this?
The performance of bonds and equities must be “uncorrelated”. In other words, when stocks go up, bond prices go down and vice versa.
Bonds are also a reliable source of income in addition to dividend payments. During a period known in trading circles as “The Great Moderation,” the blend stood the test of time, offering decent returns and some risk protection.
During the dotcom crisis, bonds cushioned the blow of falling stock prices.
So what happened in 2022?
Portfolios with the 60/40 mix fell as much as 20%. Stocks and bonds fell in tandem, as interest rates rose in the US and UK and inflation surged due to the energy crisis. Rising interest rates have hit stock prices, especially those of tech companies. Meanwhile, inflation has done damage to bond values.
What was the impact on investors?
Many were unprepared. But some institutions had moved away from the 60/40, with academics pointing out its shortcomings.
They argue that it was designed for a different era when small shareholders rather than institutions dominated stock markets, and before considerations such as ESG (environment, social and governance) drove stock-picking decisions. .
Is it RIP for 60/40?
Early in the year, many commentators argued that it was no longer relevant and should be consigned to history.
But the 60/40 still has its followers. They argue that while 2022 was a dismal year, 60/40 is a proven long-term formula and will make a comeback in 2023.
These supporters were encouraged by signs of weakening inflationary pressures. Investors have returned to bond funds, attracted by the yields offered.
How can I diversify now?
A broad allocation to UK and international equities and bonds remains logical.
But critics of the 60/40 argue that you should also have money in infrastructure, real estate and private equity, i.e. unlisted companies. These are held by certain private equity investment trusts.
The 2022 experience shows that it can be dangerous to buy and hold, and assume that everything will be fine.
It may be in the end – but there could be sleepless nights along the way.
