Are 60/40 Portfolios Still Relevant Today?

The 60/40 portfolio, consisting of 60% U.S. stocks and 40% U.S. Treasury bonds, has become the cornerstone makeup of most portfolios ever since John Bogle of Vanguard released their Balanced fund several years ago.

Generally in most years, the 60/40 portfolio has provided good returns, with some years going below expectations. In some cases, such as during periods of recession, U.S. stocks go down; in other cases, the selected stocks in the 60% allocation may not have been the best that could have been picked.

As a general statement, if you believe in the U.S. economy and government, the 60/40 allocation should work well for most people. As the U.S. economy grows, a well-selected set of stocks from the S&P 500 coupled with long-duration Treasury bonds and some short-term bills, if managed well, should give decent returns for most years.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The problem is if the assumption above is no longer true. For example, during periods of recession where the economy shrinks or contracts, stock share prices generally fall to reflect the projected smaller discounted present value cash flows they would get.

If Congress fails to rein in spending, then the U.S. debt-to-GDP ratio will keep growing. At some point, bondholders might hesitate to buy more bonds because the U.S. then becomes like a credit card holder who does not pay their bills but still insists on charging more to their card.

Then the U.S. Treasury will likely be forced to offer higher yields to attract buyers, which would raise our interest payments and thus our deficit even further. Plus, when the U.S. prints more money that is backed by debt and not actual revenue from tariffs and tax collections, inflation rises and further dampens the real economy because of the excess currency in the system.

Let me bring up the concept of an uncorrelated hedge. Correlation is when something closely follows another thing. An inverse correlation is when the opposite is true. Zero correlation is when the two things have no relationship.

Thus, if you wear a blue shirt and your friend shows up in a blue shirt, you two are positively correlated. If you wear black and your friend wears white, or vice versa, then you two are negatively correlated. If there is no pattern between you two, then there is no correlation. Note that “correlation does not mean causation,” as experts like to say, but heck, if two prices appear correlated, then that matters, right?

Kiplinger Advisor Collective is the premier criteria-based professional organization for personal finance advisors, managers, and executives. Learn more >

I believe that with the current situation, it is wise to have an uncorrelated hedge to the 60/40 allocation. Maybe 4%, more or less, but the actual ratio is up to you. Thus it might be more like 58/38/4, but you determine what it should be.

An uncorrelated hedge, like the shirt example implies, is a hedge (or protection) against situations where both stocks and bonds underperform, partially due to the reasons I described earlier. In other words, you want some of your bets to win to counteract losses in others. If all your bets are correlated, then you will lose on all of those.

Some possible uncorrelated hedges include gold, silver, ETFs, cryptos, commodities, oil, futures, fine art, luxury watches and others. Their price movements do not necessarily mirror the movements of stocks (though they sometimes do).

The thing to remember is that you need to keep these allocations to these risk-on assets small, just enough that if these go to zero, you might have a bad day but not enough to wipe you out. You also want to pick risk-on assets that have a high chance of outperforming the S&P 500 if these do well. In plain English, if you are going to take a risky bet, it better be worth it if you actually win. Otherwise, what is the point of the risk?

In financial parlance, an asset should have a high alpha (return over the S&P 500) and ideally a low beta (volatility). However, sometimes the outsized returns come from highly volatile and very speculative assets such as cryptos.

The way to approach this is that if you feel that an asset is extremely volatile price-wise, but can have a potential exponential return, then size your position so that it is small. If you lose, you will not lose much; but if it goes exponentially parabolic, you at least have a small position in it that could potentially offset any losses from your “safe” 60/40 allocation. Even if you do not fully understand what I just wrote, you already instinctively know this.

Is the 60/40 portfolio still relevant? Not in its pure form. I think it needs a third but small allocation to uncorrelated risk on hedges to make it roughly more like 58/38/4, where the 4% (the actual percentage is up to you) goes toward uncorrelated assets.

There are no guarantees in life. No one can predict the future. You could get run over just crossing the street. But if you are hedged properly with a small amount of uncorrelated assets, you might actually grow and preserve your capital despite the many rocky situations you might encounter in the future.

Related Content

• Five Ways to Diversify Your Portfolio During a Recession
• Should You Use a 25x4 Portfolio Allocation?
• The New 60/30/10 Budgeting Method