The 60/40’s Annus Horribilis

The balanced portfolio strategy of allocating 60% to equities and 40% to fixed income generated a highly satisfactory 7.9% annualized return over the last 30 years. Despite the excellent returns earned by investors following this strategic model, the past couple of years have seen a parade of articles with headlines such as “Is the 60/40 Portfolio Obsolete?” and “Is the 60/40 Dead?” Given the central importance of this moderate allocation strategy to investment industry practices, we felt a closer look at the 60/40 portfolio was in order.

Valuation Matters

Skepticism and concern over the 60/40 portfolio arose from the valuation extremes reached by each asset class in 2021. Chart 1 plots the yield-to-worst for the Bloomberg U.S. Bond Aggregate Index along with the earnings yield of the S&P 500 Index, our two asset class representatives. Despite excellent backward-looking returns for the 60/40 mix, future returns are driven by current valuations, and those were singularly unattractive in late 2020 and early 2021.

The points in this exhibit represent the joint valuation of stocks and bonds during each quarter since 1976. The four red diamonds found in the lower left portion of Chart 1 signify the last two quarters of 2020 and the first two quarters of 2021, the period when doubts about the 60/40 strategy became increasingly louder. These four quarters represent the worst joint valuations for stocks and bonds in 45 years and, starting at valuation extremes in both asset classes, it was hard to see how future 60/40 returns could come anywhere close to the long-term average.

Chart 1

As it turns out, the skeptics were right! The 60/40 strategy is having a terrible 2022, and the strategy has utterly failed in protecting investors during this severe bear market. Chart 2 depicts annual returns for the 60/40 portfolio, with the red bars measuring the contribution from fixed income, the blue bars measuring equity’s impact, and the black diamonds capturing the combined 60/40 portfolio returns.