60-40 balanced portfolio in decline but shouldn't be ruled out

Even after its recent loss, the allocation's performance over a longer period of time is still within trend, says Vanguard

60-40 balanced portfolio in decline but shouldn't be ruled out

Vanguard investing strategists advise investors not to write off the classic balanced portfolio of 60% stocks and 40% bonds, despite recent market declines.

On a webcast, senior investment consultant at Vanguard, Matthew Sheridan said, “What we would say is the 60/40 portfolio is not dead, it’s simply readjusting at this point. Prospects for the 60/40 portfolio are better now than they were two years ago.”

Any client concerns about the 60/40 portfolio's effectiveness are fair, according to Sheridan, who also noted that the allocation has been hammered by inflation at 40-year highs. The 60/40 portfolio was down 17 percent year to date as of Friday.

He also noted that much of that inflation was unanticipated, highlighting that unexpected inflation is the 60/40 portfolio's Achilles' heel.

Both equities and fixed income have been suffering difficult market conditions, which is unusual. Fixed income has been dealing with the most stressful conditions seen in the past 40 years, according to Ed Saracino, senior portfolio expert, strategy and development at Vanguard.

“You suddenly are in a position when the traditional 60/40 portfolio actually looks attractive going forward,” Sheridan added, saying that inflation is being priced into holdings.

Financial advisors can clarify that having negative returns on both equities and bonds for a six-month period is unusual.  Although the situation "feels bad right now and it's understandable," Sheridan added that given statistics spanning 50 years, it's extremely unlikely that the 60/40 portfolio will see a loss in three years.

“Our patience is being tested,” but investors need to be patient, he added.

Investors haven't had a three-year stretch of losses in both asset classes since 1976, according to Vanguard, and stock-bond diversification normally rebounds within months.

The allocation's longer-term performance isn't far off patterns, Sheridan claims, despite its recent battering. The annualized return for the past four years would be 6.5%, just below the portfolio's historical average, if the 60/40 portfolio had finished Tuesday down 17%.

Sheridan said that Vanguard anticipates the longer-term negative correlation between stocks and bonds — with returns going in opposing directions — to remain in place and that the 60/40 portfolio wasn't intended for short-term movements.

Bonds have indeed reduced returns for the 60/40 portfolio, but Sheridan pointed out that now that interest rates have risen, it is simpler for them to carry their share of the load.

The goal of the Federal Reserve's tightening monetary policy, according to Saracino, is to assist fixed income assets in generating returns that outpace inflation over the long run. He noted that investors who are willing to accept a credit risk should be aware that U.S. investment-grade corporate bonds currently yield close to 5%.

There is now a better than 50% possibility that the U.S. economy will go into recession next year. Saracino said it will be similar to the relatively mild and brief recession that followed the fall of the dotcom bubble.

In response to Vanguard's prediction of an economic downturn, he said he wouldn't advise investors to take any action.