What is the 60/40 Investment Strategy?

Looking to make your money work smarter, not harder? Consider the 60/40 investment strategy — a tried-and-true method where you divide your investments into two portions, putting 60% into stocks and 40% into bonds. This guide breaks down this simple but effective strategy, how to implement it and how it compares with other methods.

How Does the 60/40 Investment Strategy Work?

The 60/40 investment strategy is rooted in the distinct behaviors of stocks and bonds in the market. Stocks tend to be volatile yet offer higher potential returns, while bonds can provide more stable but lower returns. Blending these assets in a 60% stocks and 40% bonds ratio creates a relatively balanced portfolio potentially capable of weathering market fluctuations while providing consistent growth.

Remember, the 60/40 ratio isn't set in stone; it's a flexible guideline. You can adjust it based on your goals, preferences and risk tolerance. Some investors may lean towards a bolder strategy, like 80/20 or 70/30, while others may prefer the more cautious 50/50 or 40/60 approach. The key is discovering the mix that best aligns with your needs and expectations.

Benefits of Percentage-Based Investment Strategies

The 60/40 investment strategy appeals to investors for several reasons.

• Diversification and risk management: Diversification, a core investing principle, involves spreading investments across different assets to minimize risks tied to any single factor. With the 60/40 strategy's mix of stocks and bonds — often moving in opposing directions during market events — losses in one area can be balanced by gains in another. For instance, bonds may rise during a stock market downturn because of increased demand for safe assets, smoothing overall portfolio performance.
• Effective asset allocation: Maintaining the 60/40 ratio simplifies and optimizes asset allocation. It steers clear of over- or under-investment in specific assets, minimizing risks and ensuring a balanced, long-term perspective. By following this ratio, investors sidestep the urge to chase fleeting trends or make rash decisions during market fluctuations, promoting steadier portfolio growth.
• Historical performance and market trends: The 60/40 strategy has historically delivered consistent returns. Vanguard's study spanning 1926 to 2021 showed a 60/40 portfolio of U.S. stocks and bonds averaging an 8.8% annual return with lower volatility than both 100% stock and 100% bond portfolios. This approach aligns well with market trends, leveraging the cycles of bull and bear markets. During bull markets, the 60/40 mix captures growth, while during bear markets, it can mitigate losses. 

Potential Challenges and Considerations

Despite its advantages, the 60/40 investment strategy comes with notable challenges and considerations:

• Market volatility: While the 60/40 mix aims to reduce overall portfolio volatility, it doesn't eradicate it entirely. Periods exist when both stocks and bonds undergo significant declines or fluctuations, impacting portfolio value and performance. In the 2020 COVID-19 pandemic, a 60/40 portfolio would have dropped roughly 20% in a month. You must brace yourself for such market volatility and stay committed to your long-term investment plan.
• Interest rate and bond yield changes: Interest rates and bond yields significantly influence the 60/40 strategy's performance. Bond prices fall when rates and yields rise — since bonds pay fixed interest — which can drag down the overall portfolio performance. Over the past decade, historically low interest rates and bond yields boosted the strategy's performance. However, as the global economy recovers, inflation pressures, rates and yields have risen, and the bond portion of the portfolio has come under pressure.
• Changes in correlation: A premise of the 60/40 strategy is that bonds and stocks generally move in opposite directions, creating a relatively hedged and stable portfolio. However, stocks and bonds have gone through long periods where they move in unison, in which case the overall risk profile might be higher than expected.
• Periodic evaluation and adjustments: The 60/40 strategy demands regular assessment and adjustments. As your portfolio evolves, deviations from the 60/40 target might occur because of varying returns and volatilities of stocks and bonds. For instance, strong stock performance might skew the balance towards stocks, while robust bond performance could shift it towards bonds. Monitoring and rebalancing your portfolio — selling assets that gained value and purchasing those that decreased — helps restore the ratio. However, this process incurs costs and taxes that could diminish returns.  

Implementing This Investment Strategy

To kickstart your 60/40 investment strategy, follow these steps to build your portfolio:

• Selection criteria for stocks and bonds: Begin by outlining the types of stocks and bonds that align with your investing portfolio. Stocks may vary based on size, style, sector and geography, while bonds differ in duration, credit quality, issuer and geography. Tailor your choices to match your goals and risk tolerance, aiming for diversity across stocks and bonds to minimize single-risk exposure.

Consider employing index funds or exchange-traded funds (ETFs) mirroring well-known indices like S&P 500 (US stocks), MSCI EAFE (international stocks), Bloomberg Barclays US Aggregate Bond (US bonds) and FTSE World Government Bond (international bonds). Alternatively, actively managed funds or individual securities can align more closely with your criteria, like dividend stocks, growth stocks or specific bond types. However, recognize that active management and individual securities may involve higher costs and risks.

• Adjustments and rebalancing techniques: Maintaining the 60/40 ratio requires periodic adjustments:
• Time-based rebalancing: This involves rebalancing at set intervals (monthly, quarterly, annually) regardless of market conditions. While simple, it may lead to unnecessary costs if deviations aren’t significant.
• Threshold-based rebalancing: You rebalance only when the deviation from the target ratio surpasses a specific percentage (e.g., 5% or 10%). For example, if aiming for 60/40, you'd rebalance at 65/35 or 55/45. This method is more cost-effective but demands closer monitoring.
• Hybrid rebalancing: A mix of time-based and threshold-based methods, like rebalancing annually, but only if the deviation exceeds a certain percentage. This approach balances the benefits of both methods but can add complexity.

Example of This Strategy in Action

Consider an investor with $100,000 to invest, aiming to apply the 60/40 strategy.

Allocation of Funds

• Stocks: $60,000 (60%). Allocation: 70% to U.S. stock index (S&P 500) and 30% to the international stock index (MSCI EAFE).
• Bonds: $40,000 (40%). Allocation: 70% to U.S. bond index (Bloomberg Barclays US Aggregate Bond) and 30% to the international bond index (FTSE World Government Bond).

Rebalancing and Performance

• Annual rebalancing method used with a 5% deviation threshold. This process entailed selling and buying assets to restore the desired allocation. 
• Expected annual returns: 10% for stocks and 5% for bonds.
• Over a 10-year period, the portfolio value grows from $100,000 to $172,426, averaging a 5.7% annual return. 

Observations

The 60/40 strategy facilitated portfolio growth while sticking to the desired allocation by periodically rebalancing, ensuring the investor retained the intended risk profile throughout the investment horizon.

Alternative Investing Strategies

When aiming for a balanced investing portfolio, the 60/40 strategy isn't the sole option available. Consider these alternative approaches:

• 80/20 or 70/30 strategy: These strategies allocate 80% or 70% to stocks and 20% or 30% to bonds, respectively. They're more aggressive, favoring higher exposure to stocks and lower exposure to bonds. While they aim for higher returns, they come with increased risk and volatility. They are suited for those with longer investment horizons, higher risk tolerance and greater growth expectations.
• 50/50 or 40/60 strategy: In contrast, these strategies allocate 50% or 40% to stocks and 50% or 60% to bonds, respectively. They're more conservative, emphasizing income generation and reducing risk through higher bond exposure. While they may yield lower returns, they offer reduced volatility, fitting those with shorter time horizons, lower risk tolerance and conservative growth expectations.
• Diversification with other asset classes: Exploring assets like cash, real estate, commodities, gold or cryptocurrencies presents an opportunity for added diversification. However, these asset classes may introduce higher costs, taxes, complexity and uncertainty. They demand thorough research and understanding of their pros and cons before being integrated into a portfolio.

Each alternative allows investors to tailor their portfolios based on individual risk tolerance, time horizons and growth expectations, acknowledging the trade-offs inherent in each strategy.

Crafting a Balanced Portfolio

The 60/40 method remains a simple and frequently used investment approach, combining risk management with growth opportunities. Its reliance on two major asset classes and flexibility to suit can improve its resilience through market changes. Yet, understanding its details and regularly reviewing and exploring other strategies helps investors customize portfolios to match their goals and risk levels.

Frequently Asked Questions