Vanguard predicts that the 60/40 investment portfolio might experience significant growth in the coming decade.

According to Morningstar, the 60/40 portfolio has recently demonstrated its resilience following the bond market turmoil of 2022. In early August, when the stock market experienced a significant downturn, high-quality bonds provided the expected defensive support, noted Jason Kephart, Morningstar’s director of multi-asset ratings. The Morningstar U.S. Market Index, which tracks stock performance, fell by 6.3% from August 1 to August 5, marking its worst five-day stretch since June 2022. Conversely, the Morningstar U.S. Core Bond Index increased by 1.5% as investors sought safer assets. Kephart explained that the stock market decline wasn’t driven by inflation, allowing bonds to perform their traditional role effectively. The 60/40 strategy, which allocates 60% to stocks and 40% to bonds, aims to reduce portfolio volatility by balancing the typically inverse movements of these asset classes. However, in 2022, both stocks and bonds suffered due to the Federal Reserve’s interest rate hikes to combat inflation, causing the iShares Core Growth Allocation ETF (AOR), which mirrors the 60/40 portfolio, to drop by 17.4%.

Since then, the 60/40 strategy has rebounded, achieving a cumulative return of 20.5% from 2022 to May 2024, according to Vanguard. Despite the 2022 setback, it has maintained an annual return of 6.2% over the past decade, largely driven by strong equity performance, stated Zachary Rayfield, head of goals-based investing research at Vanguard. The firm anticipates a promising decade for the 60/40 strategy, expecting bonds to play a more significant role in overall portfolio performance and downside protection, even if equity outperformance diminishes. However, Kephart warned that inflation-induced volatility could impact performance, as rising interest rates typically lead to falling bond prices and higher yields, which can negatively affect stocks. Currently, inflation appears to be cooling, with the consumer price index rising by only 0.2% in July, resulting in a 12-month inflation rate of 2.9%. If this trend continues, bonds are likely to remain a reliable defensive asset, Kephart suggested.

Building a 60/40 portfolio involves creating a balanced and diversified investment mix, which can be adjusted based on an individual’s age, retirement timeline, and specific needs. Rayfield from Vanguard emphasized that the 60/40 allocation provides a good starting point, offering flexibility for various market and goal scenarios. Certified financial planner Marguerita Cheng, CEO of Blue Ocean Global Wealth, recommended diversifying within the equity portion by including a range of market capitalizations, from large-cap to small-cap stocks, and incorporating international and emerging markets based on the client’s age and risk tolerance. She also advised mixing growth and value stocks to benefit from different market cycles. For the fixed income portion, Cheng suggested diversifying by maturity and credit quality, and for wealthy clients, including municipal bonds for their tax advantages. She cautioned against funds that use leverage or take on excessive risk, recommending total return or strategic income funds for those unsure of what to include.

Kephart from Morningstar advised that high-quality bonds are a safe bet currently, suggesting funds that track the Bloomberg Aggregate Bond Index. He noted that high-yield or junk bonds have not historically been effective diversifiers and recommended avoiding complex investments like liquid alternative funds. He argued that claims of the 60/40 strategy being “broken” or “dead” are often attempts to sell more complex and expensive products, which do not necessarily yield better results. For a straightforward approach, Kephart recommended investing in the S&P 500 and Bloomberg Aggregate Bond Index for a solid portfolio.