There are many different strategies when it comes to building an investment portfolio, but each involves investing in a certain percentage of various assets, and some also involve buying and selling assets at particular times. One of the most popular strategies recommended by financial advisors is called the 60/40 portfolio, which involves building a portfolio which contains 60% equities (stocks) and 40% bonds.
Like any investment strategy, this simple long-term approach has both upsides and downsides. Let’s look into the details of the 60/40 portfolio, its pros and cons, and who it’s best suited for.
What is the 60/40 Portfolio?
Investment holdings divided as 60% stocks and 40% bonds is commonly understood to be a “60/40 portfolio”. The strategy behind the 60/40 portfolio is that when the economy is strong, stocks perform well, and when it’s weak, bonds perform well. By holding more stocks than bonds, investors can take advantage of growth over time, and the bonds mitigate the risk of losing a huge amount of their portfolio during downturns. The 60/40 portfolio is designed to withstand volatility and grow over the long-term.
60/40 Portfolio Historical Returns
Over the past century, the 60/40 portfolio was very popular because of its reliable returns. Although it hasn’t always performed as well as an equity-only portfolio, it carries less risk and is less volatile. However, historical returns aren’t necessarily an indicator of how the 60/40 portfolio will perform in the future.
Since 1928, a 60/40 portfolio containing 10-year U.S. Treasuries and the S&P 500 has had an average annual return of 9%. With inflation factored in, that return decreases to 5.9%.
The 60/40 portfolio grew 7000% since the 1970s, with only a 30% maximum decline.
Unfortunately, returns on the 60/40 portfolio are predicted to be lower in the coming decades than they have been in the past. This is due to a few factors:
• Inflation: As inflation increases, purchasing power decreases. Currently, a lot of bond yields aren’t even keeping up with the rate of inflation, with rates under 2%, and this may continue for a long time.
• Real GDP Growth: Real GDP is the amount of national economic growth minus inflation. As the economy has matured in recent years, the GDP has been growing more slowly than in decades prior.
• Dividend Yields: The amount that companies pay out through dividends is typically much lower now than it used to be.
• Valuation: Companies are valued much higher than they used to be, and large companies are growing more slowly. Investors can expect slower growth in stock earnings.
How to Build a 60/40 Portfolio
The simplest way to build a portfolio with 60% equities and 40% bonds would be to purchase the S&P 500 and U.S. Treasury Bonds. This portfolio would include mostly U.S. investments, though some investors might choose to diversify into international investments by purchasing foreign stocks and bonds.
Financial advisors putting together a 60/40 portfolio for investors generally include high-grade corporate bonds and U.S.government bonds, along with index funds, mutual funds, and blue-chip stocks. This combination avoids taking on too much risk— which is a possibility if they purchase an unknown stock and it fails—and typically yields steady growth over time.
Investors may also choose to invest in exchange-traded funds (ETFs), which are mutual funds that are traded on an open market exchange (like the New York Stock Exchange), just like stocks. By investing in funds, investors increase their exposure to different companies and industries, thereby diversifying their portfolio. There are many types of ETFs. Some of them are groups of stocks within a particular industry, while others are grouped together by company size or other factors.
If an investor were looking to generate income from their investments, they might choose to buy dividend-paying stocks and real estate investment trusts (REITs).
In terms of bonds, there are also a number of options. Investors might choose to buy municipal bonds which earn tax-free interest, or high-yield bonds which earn more than other bonds but come with increased risk.
It’s recommended that investors rebalance the portfolio annually to ensure the percentages remain on track.
Pros of the 60/40 Portfolio
The 60/40 portfolio is a simple strategy which has several upsides:
• It can be very simple to set up, especially by purchasing the S&P 500 and U.S. Treasury Bonds
• It’s a “set it and forget it” investment strategy, needing only yearly rebalancing
• Holding bonds helps balance the risk of equity investments
• It typically offers steady growth over time
Cons of the 60/40 Portfolio
Of course, as with any investing strategy, the 60/40 portfolio strategy comes with some downsides. The 60/40 portfolio used to be the standard choice for retirement, but people are living longer now and need a portfolio that will continue growing steadily and quickly to keep up with inflation. Here are some other factors to consider:
• If investors buy individual stocks, they can be volatile
• Mutual funds and ETFs can have high fees
• Bonds tend to have low yields
• The strategy doesn’t take into account personal goals and factors such as age, income, and spending habits
• Limited diversification: Investors can also add alternative investments, such as real estate, to their portfolio
• There is potential for both stocks and bonds to decline at the same time
• Over time, a 60/40 portfolio won’t grow as much as a portfolio with 100% equities. This is especially true over the long-term because of compounding interest earned with equities.
Who Might Use the 60/40 Portfolio Strategy?
Some investors can’t sleep at night if they’re afraid their stock portfolio is going to crater overnight. Using the 60/40 strategy can take some of that anxiety away.
The 60/40 strategy is also a viable choice for those who don’t want to make a lot of decisions and just want simple rules to guide their investing. Beginner investors might decide to start out with a 60/40 portfolio and then shift their allocations as they learn more.
Additionally, those who are closer to retirement age may choose to shift from a stock-heavy portfolio to a 60/40 portfolio, in an effort to reduce risk and ensure they have enough savings to fund their retirement.
Investors who have a high risk tolerance and are looking for a long-term growth strategy might not gravitate toward a 60/40 plan, and instead choose to allocate a higher percentage of their portfolio to stocks.
Alternatives to the 60/40 Portfolio
In recent years, some major financial institutions have declared that the 60/40 portfolio is dead, and have been recommending that investors shift more towards equities, since bonds have not been returning significant yields and don’t provide enough diversification. Some suggest holding established stocks that pay dividends rather than bonds, to get a balance of growth and stability.
However, these recommendations are partly based on the fact that the current bull market is over, and they aren’t necessarily looking at the long-term market.
There are many other investment strategies to choose from, or investors might create their own rules for portfolio building. Here are a few common strategies:
This portfolio allocates 25% each to stocks, bonds, gold, and cash.
The Rule of 110
This strategy uses an investor’s age to calculate their asset allocation. Investors subtract their age from 110 to determine their stock allocation. For example, a 40-year-old would put 70% into stocks and 30% into bonds.
Using this strategy, investors put the same amount of money into any particular asset at different points over time.
This way, sometimes they will buy high and other times buy low, and over time the amount they spent on the asset averages out.
Investors may consider allocating a portion of their funds to alternative investments, such as gold, real estate, or cryptocurrencies. These investments can help increase portfolio diversification, mitigate risk, and may generate significant returns.
The 60/40 portfolio investing strategy—where a portfolio is comprised of 60% stocks and 40% bonds—is a popular one, but it’s not right for everyone. Though it carries less risk and is less volatile than a portfolio that contains only stocks, making it a traditionally safe choice for retirement accounts, experts worry that the current and expected future rate of return isn’t enough to keep up with inflation.
For investors who want a simple “set it and forget it” investment strategy, the 60/40 portfolio can be appealing. Other investors may decide to investigate alternative strategies, including the permanent portfolio or the rule of 110.
As always, the first step in building a portfolio is creating personal goals. Investors can make a plan based on their expected income, how much time they plan to spend on investing, and other personal factors. With a plan in place, it usually makes sense to stick with it, rather than switching strategies every time the market changes.
One easy way to get started building a portfolio is by using an online investing platform like SoFi Invest®. The investing platform makes it simple to buy and sell stocks and other assets right from your phone, with just a few clicks. There are zero transaction, membership, or hidden fees. Using the platform you can research and track your favorite stocks and set up personal investing goals.
SoFi offers both automated and active investing, so you can either choose each stock you want to buy, or choose from pre-selected groups of stocks and ETFs. If you need help getting started, SoFi has a team of professional advisors available to answer your questions and help you create a personalized financial plan to reach your goals.
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