Does the Classic 60/40 Investment Strategy Still Work for Retirement?

The 60/40 investment strategy is a classic guideline suggesting that investors allocate 60% of their portfolio to equities and 40% to fixed income assets like bonds.

While stocks offer the potential for high returns, they come with greater risk and volatility. Bonds, on the other hand, typically provide lower, more consistent returns and help stabilize the portfolio during market downturns.

This investment rule has long been a staple in personal finance. However, it faced significant scrutiny and skepticism from the investment world recently.

Throughout 2023 and into early 2024, numerous analyses and opinion pieces questioned the viability of the 60/40 allocation, suggesting it might not be sufficient for a balanced portfolio in modern times and proposing various alternatives.

The skepticism stemmed from the events of 2022 when the bond market experienced one of its worst years on record. This downturn was driven by soaring inflation and increasing interest rates.

As 2024 nears its end, the sentiment towards the 60/40 strategy is becoming more positive once again.

Is the 60/40 Rule Still Relevant?

Vanguard recently reinforced the 60/40 split as an excellent baseline for long-term investors, asserting its relevance in today’s market just as in the past.

Other financial experts agree. Jonathan Lee, a senior portfolio manager at U.S. Bank, supports the 60/40 rule as a solid benchmark for maintaining a balanced portfolio.

Todd Jablonski, the global head of multi-asset investing at Principal Asset Management, also strongly believes in the 60/40 rule’s efficacy, humorously noting he could quote Mark Twain in its defense.

The rationale behind the 60/40 rule is grounded in the need for a well-balanced investment approach, particularly as one nears retirement.

Equities have historically returned about 10% annually, significantly higher than ordinary savings accounts. However, the stock market can be unpredictable and may plunge during economic downturns.

Bonds are generally perceived as safe and predictable, which theoretically makes them an ideal counterbalance to stocks. In practice, when stock values decline, bond values are expected to rise.

The Chaotic Bond Market of 2022

In 2022, the financial landscape was upended. The S&P 500 dropped by 18.6%, while bond values fell by 13.7%, as per the Vanguard Total Bond Market Index. Adjusting for inflation, this represented the worst performance for bonds in nearly a century, a NASDAQ analysis indicated.

This drastic downturn led some investors to reconsider the foundational principles of retirement savings, including the 60/40 rule.

This poor performance was primarily due to aggressive interest rate hikes by the Federal Reserve in response to a 40-year peak in inflation rates.

Higher interest rates decrease the market value of bond funds, and inflation further diminishes their appeal by eroding the real returns they offer. When inflation exceeds the interest rate a bond pays, the effective yield becomes negative.

Even before 2022, the performance of bonds had been lackluster, largely due to historically low interest rates resulting from the Great Recession and later, the COVID-19 pandemic. This environment typically results in lower yields on bonds.

“Investors started questioning just how much lower bond returns could go,” Jablonski remarked.

A Shifted Perspective in 2024

The bond market landscape has significantly changed today. Inflation has moderated, and while interest rates have declined, they remain relatively high, leading to attractive yields on new bonds.

Investors adhering to the 60/40 rule are seeing favorable outcomes.

According to Jablonski, the 60/40 portfolio saw a decline of 15.8% in 2022 but rebounded with an increase of 17.7% in 2023. As of November 2024, the portfolio is up by 15.5%.

“This represents a strong level of return,” he stated.

Despite the challenging year in 2022, Vanguard’s analysis shows that over the past decade, the 60/40 strategy has averaged an annual gain of 6.9%.

“The past ten years have been particularly good for 60/40 due to strong stock market performance,” explained Todd Schlanger, a senior investment strategist at Vanguard.

However, with the stock market currently considered overvalued, future returns for 60/40 portfolios might be lower than in previous years, according to Schlanger.

But he emphasized that bonds are poised to play a more significant role in the coming decade than they did in the previous one.

Currently, the yield on a 10-year Treasury bond is about 4.3%, according to CNBC, outpacing inflation and making bonds increasingly attractive.

“People are starting to favor bonds again due to the higher interest rates,” Lee mentioned.

Rising Bond Yields Amid Growing Deficits

One factor contributing to the high yields on long-term bonds is the concern over the federal government’s escalating debt.

Following the re-election of Donald Trump, the yield on a 10-year Treasury note hit its highest point in months.

Trump’s policies, which include tax reductions, are expected to increase the federal deficit, which currently stands at $1.8 trillion.

According to Jablonski, the rising bond yields are partly due to the perceived risk of the government’s fiscal policies.

This reflects another fundamental principle of finance: borrowers perceived as less creditworthy must offer higher interest rates, even if that borrower is the government.