Investing strategies don't get more classic than the so-called 60/40 allocation. By holding 60% of your portfolio in stocks and 40% in bonds, the thinking goes, you get the best of both worlds: high growth potential from your riskier stocks and protection from your more conservative bonds.
For investors who hold this portfolio mix or one similar to it, however, this year has been tough. From the start of 2022 through September 28, a 60/40 portfolio invested in line with benchmark U.S. stock and bond indexes shed 20%. Only two calendar years — both during the Great Depression — have been worse.
Factor in rising prices, and things get even darker. "On an after-inflation 'real' basis, this is currently likely to be the worst year ever for a traditional 60/40 stocks and bonds portfolio," tweeted Meb Faber, cofounder and chief investment officer at Cambria Investment Management.
Here's why things have been so bad for balanced portfolios, and what, if anything, investing pros say you can do about it.
Why the 60/40 portfolio is in trouble
The 60/40 portfolio is designed for moderate risk and moderate returns. This counts on the fact that while the stock market periodically goes down, and the bond market periodically goes down, they rarely go down at the same time — a phenomenon that investing pros call having a low (or negative) correlation.
"For the past two decades, the stock/bond correlation has been consistently negative, and investors have largely been able to rely on their bond investments for protection when equities sell off," wrote researchers at investment firm AQR earlier this year.
Not so this year. In response to rampant inflation, the Federal Reserve has embarked on the largest six-month increase to interest rates in 41 years. Fear among investors that the Fed's actions could tip the economy into a recession have sent stock prices down nearly 23% on the year.
Because bond prices and interest rates move in opposite directions, the broad bond market has fallen more than 14% since the year began.
Those stock and bond returns are notable for two reasons:
- Should returns on both indexes stay negative, it will be the first year that stocks and bonds both log a negative return since 1969, according to investing research firm Callan.
- As it stands, this is a major loss for the bond market. If the current return holds, "this would be about three times worse than the next-worst decline in 30 years," says Kevin J. Brady, a certified financial planner and vice president at Wealthspire Advisors in New York City.
Sticking to the plan: 'A year does not a fortune make or break'
Before you make any changes to your asset mix, it's worth it to remember what your original allocation was there for in the first place.
"Asset allocations are designed to be followed over the course of many years," says Charles Rotblut, vice president of the American Association of Individual Investors. "You shouldn't abandon it because it's not working now."
The 60/40 model is common among people who are within five to 10 years of retirement and those who are already taking withdrawals from retirement accounts, says Rotblut.
If you're in that camp, it may make sense to make some tweaks to your strategy since more turbulence could be on the horizon if the Fed continues to hike rates. The main one: adding cash.
"You always want to have some safe money," says Michael Hausknost, a CFP in Long Beach, California. "Cash may be worth a little less because of inflation, but you do not want to be dependent on your stock or bond portfolio for any immediate needs."
For those in retirement hoping to make their money last, Hausknost recommends a slightly more aggressive portfolio, with 70% of the portfolio in stocks, 25% in bonds and 5% in cash.
It's key that the cash you have in your portfolio is accessible, he adds. "It's there purely for those 'in-between' down years to pay for ongoing living expenses so that the investor doesn't have to liquidate other investable assets when they are down."
Ultimately, though, the No. 1 thing to remember is to not overreact to short-term fluctuations in your portfolio, Hausknost says. "People need to be reminded, especially since we're talking about retirement assets, a year does not a fortune make or break."
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As an investment expert deeply familiar with various portfolio strategies and financial markets, I can provide comprehensive insights into the concepts and strategies referenced in the article about the 60/40 portfolio allocation and the challenges it faced in 2022.
60/40 Portfolio Allocation: The 60/40 portfolio strategy involves a balance of 60% in stocks and 40% in bonds. This allocation aims to capitalize on the potential high growth from stocks while leveraging the stability and income generation of bonds.
Challenges Faced by the 60/40 Portfolio in 2022:
- Market Performance: The article notes that the 60/40 portfolio, aligned with U.S. stock and bond indexes, faced a significant decline of 20% from the start of 2022 through September 28.
- Unprecedented Performance: This performance is remarkable because it ranks among the worst in history, comparable only to specific years during the Great Depression.
- Stock-Bond Correlation: The portfolio traditionally relies on the negative correlation between stocks and bonds, providing a buffer during market downturns. However, this negative correlation did not hold in 2022 due to unique market conditions.
Factors Contributing to the Poor Performance:
- Inflation Impact: Rampant inflation triggered a response from the Federal Reserve, leading to a rapid six-month increase in interest rates, causing fear among investors about a potential economic recession. This resulted in a significant drop in stock prices (nearly 23% for the year).
- Bond Market Response: Bond prices moved inversely to interest rates, causing a decline of over 14% since the year began.
Expert Recommendations and Strategies:
- Long-Term Perspective: Financial experts emphasize that the 60/40 allocation is designed for long-term success, and investors shouldn't hastily abandon this strategy due to short-term market volatility.
- Adjustments for Near-Retirees: For individuals nearing retirement or already in retirement, subtle adjustments may be prudent. Some experts recommend a slight increase in cash holdings to weather potential turbulent times.
- Importance of Liquidity: Maintaining accessible cash reserves within the portfolio is crucial, especially for retirees, to cover living expenses during market downturns without selling off depreciated assets.
Key Takeaway: The essence of the advice is not to overreact to short-term market fluctuations and to maintain a balanced approach, particularly for retirement assets. The 60/40 allocation might face challenges in specific market conditions, but its strength lies in its long-term resilience.
Should you require more detailed information or specific guidance on investment strategies, portfolio allocations, market conditions, or risk management techniques, I'm well-equipped to delve further into these topics and provide tailored insights.
