The 60-40 allocation, 60% in stocks coupled with 40% bonds, has served investors well for years as a default template for financial advisors to capture the upside in equities while protecting the downside with safe-haven bonds. Fast forward to the current market environment, and what has worked then doesn’t necessarily work now.
The 40% allocation into bonds has proven to be a challenge given that Treasury note yields have gone to basement-low levels. With more investors adding bonds to their portfolios, it’s skyrocketed bond prices and driven yields down to a point where negative rates are entering fixed income vernacular–does this mean the 60-40 strategy is dying off?
“We believe that the old 60/40 model just won’t be able to cut it anymore,” said Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School and senior investment strategy advisor at WisdomTree. “This environment of low interest rates is not going to change.”
Siegel also made light of the fact that the dividend yield on the S&P 500 is currently higher than the yield on the U.S. 10-year Treasury’s 1.5%. “How is [that]… going to give you enough income?”
So What Works Instead?
In the current low yield environment, how can investors still quench their thirst for income while still getting the necessary core bond exposure? Siegel offers up 75-25 stock-bond allocation as an alternative.
“That’s why we recommend 75/25 as the equity/fixed-income allocation,” said Siegel, adding that it “would be the best way for those approaching retirement to establish their assets to get enough income and gains so they can maintain spending through retirement.”
Central banks around the globe have been keen on keeping interest rates at lows with some countries resorting to negative yields on government debt. How long can this keep up?
With the population getting older and more risk averse, the low yield environment could be around for some time.
“All these factors are going to keep these interest rates in these levels very long, and you cannot survive on a one-and-a-half-percent nominal interest rate,” Siegel said. “Look at the TIPS yield. The real interest rates are negative now. It cannot maintain spending streams at all. Dividends on stocks are going to be the new bond in terms of thinking about retirement.”
ETFs for the 75-25 Split
Investors who want to mimic the 75-25 split with ETFs can look at broad-based funds that offer exposure to both stocks and bonds. For the former, investors can look at the SPDR S&P 500 ETF (NYSEArca: SPY), which has been a staple fund for many years.
For fixed income, investors can look at the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG), which has been the go-to fund for core bond exposure. AGG offers broad exposure to U.S. investment-grade bonds and a low-cost easy way to diversify a portfolio using fixed income.
For more market trends, visit ETF Trends.