The 60% equities/40% fixed income portfolio split has been relied on by advisors and clients for generations. However, longevity doesn’t always equate to efficiency, and there are some market observers who now believe that 60/40’s best days are behind it.
With equities richly valued and bond yields depressed, 60/40 could be challenged to hold up the way it did in the past. Inflation that’s proving more persistent than previously expected is only compounding those woes.
“For the bond index, the current yield is 1.6% with a duration of 6.8. If interest rates modestly increase over the period, returns would be roughly 1% annualized, bringing the 60/40 portfolio return to roughly 4%. The caveat, which is needed every time we talk about planning for the future, is that equity valuations and interest rates have proven to be extremely difficult to predict,” notes Nationwide’s Mark Hackett.
While valuation alone isn’t a reason to run into or abandon stocks, it’s becoming increasingly apparent that at least one interest hike by the Federal Reserve is coming next year, and that will weigh on bonds, putting some strain on the 40 in 60/40 portfolios.
Rising interest rates — more of which are expected in 2023 — could also hinder equity returns because some sectors are negatively correlated to higher borrowing costs. Add all that up, and it’s possible that investors could be in for a lengthy spell of more muted returns, diminishing the allure of 60/40 in the process.
“After the tremendous run for equities and bonds, a period of more modest returns is not unexpected or unhealthy, but it will likely challenge investors that have become accustomed to consistent double-digit returns,” adds Hackett.
While 60/40 has long been viewed as the gold standard of portfolio construction, investors have plenty of asset classes to turn as alternatives to 60/40.
“For example, small-cap, value and international stocks are all trading at less of a premium to their historical averages than large-cap, domestic growth stocks. Also, given that 22% of the S&P 500 is concentrated in the largest five technology companies, active management could provide opportunities. Finally, dividend-focused equities, credit-sensitive bonds, and alternative strategies may provide greater yield than traditional bond allocations,” concludes Hackett.
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