A new year can bring the adoption of a new perspective, which also applies to portfolio exposure. With that, the tried-and-tested 60-40 portfolio may be best flipped by instead using a 40-60 portfolio in a year that brings more uncertainty.
Interest rate decisions remain in flux while ongoing geopolitical tensions and economic uncertainties carry over from the previous year. Furthermore, stock market valuations may have reached a peak; the artificial intelligence (AI) frenzy may have stretched prices to the limit. As mentioned in an Advisor Perspectives article by Wealth Logic founder Allan Roth, Vanguard’s market simulation forecast is projecting underperformance by U.S. stocks compared to other assets (notably international equities) in the next 10 years.
In a recent video, Vanguard Global Head of Portfolio Construction Roger Aliaga-Díaz explained why a 40-60 portfolio may be the ideal allocation given the current times.
“It’s not pessimism about AI or the economy,” noted Aliaga-Diaz. “It’s about risk from a stock market correction.”
With that, bonds remain the ideal ballast to shore up a portfolio. While rate cuts are to be expected, interest rates are still relatively high compared to previous years. Tilting more heavily towards bonds offers more portfolio protection. Additionally, it offers the potential for returns that mimic the traditional 60-40 allocation—sans the additional risk that equities carry.
“Bonds remain attractive in the high-interest-rate environment,” Aliaga-Diaz added. “Our models project that, over the next decade, a 40/60 portfolio can achieve similar returns to a 60/40, but with less risk. In other words, markets may not appropriately reward the additional risk of stocks.”
Tilt Towards Treasuries
Which bonds are ideal given the current market environment? Vanguard prefers the safe haven of Treasuries, especially during times of uncertainty.
“We also balance risk within asset classes,” Aliaga-Diaz said. “Corporate debt valuations are stretched, so we’re cautious about credit and high yield, but we’re overweight Treasuries.”
Given this, there’s three options that cover the full yield curve spectrum when it comes to Treasuries exposure: the Vanguard Short-Term Treasury ETF (VGSH), the Vanguard Intermediate-Term Treasury Index Fund ETF Shares (VGIT), or the Vanguard Long-Term Treasury Index Fund ETF Shares (VGLT). All funds feature low expense ratios of 0.03% or $3 per every $10,000 invested.
While VGSH is ideal for mitigating rate risk, VGLT can appeal to those looking for greater yield. VGIT strikes a balance between mitigating rate risk and attaining yield with intermediate exposure. All three funds can be used as stand-alone products or alternatively, use the trio in a bond laddering strategy. This allows a fixed income portfolio to remain flexible regardless of the Fed.
For more news, information, and analysis, visit the Fixed Income Content Hub.
