This piece was inspired by this fantastic Josh Brown rant on CNBC about how the 60/40 stock/bond portfolio isn’t dead. Give it a watch.
The 60/40 stock/bond portfolio is the gold standard of portfolios. It’s diverse, low cost and extremely hard to beat in the long-run mainly because it’s a very close approximation of the Global Financial Asset Portfolio. This overall simplicity and efficiency is why so many high fee active money managers despise it and are consistently saying it’s “dead”. This doesn’t mean a 60/40 is right for everyone or that it has no flaws, but declaring it “dead” makes little sense, especially in today’s higher interest rate environment.
Now, I have my own nuanced issues with a 60/40, specifically:
- I don’t think it always makes sense to rebalance back to a fixed 60% equity weight when we know that that deviates from global market caps significantly and can, at times, add a lot of risk to a portfolio because the 60% slice is so much riskier than the 40% slice.
- Owning a 60/40 via a single fund can create a lot of homogeneous asset class risk and liquidity risk because you can’t tap the specific liquid components in the portfolio. This became uncomfortably clear to investors in 2022 who might have needed cash from their portfolio, but couldn’t liquidate the actual cash component of the 40 without liquidating some portion of the entire 60 and 40.
- I don’t love a standalone bond aggregate as a 40% bond slice. I think bonds need to be more actively managed across time to account for personal liquidity needs as well as duration/credit risk.
These are mostly quibbles applicable to specific investors. As a whole, I very much agree with the view that owning a very diversified stock/bond portfolio of some sort should be the core component of anyone’s savings portfolio. Of course, I am an even bigger advocate of doing this the way John Bogle did it using a countercyclical behavioral approach. But when people declare that 60/40 is “dead” they’re essentially saying that stocks and bonds are dead. This is irrational/emotional storytelling. Let’s put some numbers to this to explain why.
In my All Duration model the stock market is an 18 year instrument so predicting the short-term swings of that instrument will always be difficult. But we know, in the long-run, that stocks are very likely to generate positive returns over multi-decade periods. That 60% slice might become incapacitated for long periods of time, but it very likely won’t “die” unless corporate America dies. That’s not a great bet in my opinion.
The math on the 40% slice is much cleaner. A bond aggregate is about a 5 year instrument in my All Duration model. Now, when interest rates were 0% that instrument had a lot of interest rate risk in large part because the yield on the bonds wouldn’t offset the interest rate risk. But in today’s environment you’re getting 5% on T-Bills and 3.75% on a 5 year note. When that 5 year instrument was yielding 0.25% like it was in 2020 that meant that every 1% increase in interest rates was offset by just 0.25% of interest along the way. With a duration of 4 that meant you lost 3.75% for every 1% upward move in rates. But in today’s environment the yield now offsets most of the interest rate risk. For every 1% move in rates you’re now protected by the 3.75% coupon. In order to lose money on an annual basis the Fed would have to move more than 1% per year every year going forward. And it looks much more likely at this point that the Fed is either done, close to done, OR closer to cutting rates in the coming years as inflation comes down. Said differently, the risk/reward on bonds looks better than it has in a very long time and people selling bonds today are selling low.
So here’s the thing – we don’t know how risky the 60% slice of stocks is in the coming years. But we know, with a high probability that the 40% slice of bonds is becoming much more attractive. So yes, as Josh notes in his interview, these criticisms were more valid in 2020 when interest rates were at 0%. But in today’s environment the aggregated components of a 60/40 look much more attractive than they have in a very long time in large part because we know that the 40% slice is a lot more attractive than it has been in decades.