‘60/40’ balanced portfolio – what is it and should investors consider it for the future?

The ‘60/40’ portfolio is a mix of shares (60%) and bonds (40%). It’s used as a general guideline for lots of investors when building a balanced investment portfolio for the long term. Shares are expected to provide most of the growth. While bonds are there to help smooth the ups and downs, offer an extra source of income, and lower the overall risk.

Why do investors use it?

It’s difficult to consistently perform well by switching between different types of investments, like shares and bonds. So a framework like 60/40 can guard against the temptation to try and ‘time’ the market. Having this kind of simple rule can help us stay the course and make us less prone to emotional responses to setbacks, like getting out of the market after a big loss.

Has it worked in the past?

Compared to only investing in shares, a ‘balanced’ 60/40 portfolio in the past has helped smooth out the ups and downs of investing in the stock market. It’s also reduced the chances of making a loss, and given investors a decent return along the way by beating inflation.

Over the past 30 years, a 60/40 asset mix delivered a return of 8.5% per year, while inflation (measured by the UK Consumer Price Index) increased 2% per year. The worst drawdown (peak to trough loss) for the 60/40 portfolio over the same time was 25.9%, versus 48.3% for a pure global shares investment.

Bear in mind that these numbers are based on indexes and assume no costs, whereas investors incur costs if they invest in a fund. They also assume the use of global equity and bond benchmarks that include the UK – holding a greater UK ‘home bias’ would’ve lowered returns over this period depending on how much was invested there, but still comfortably outpaced inflation.

Of course, past performance doesn’t guarantee future returns. Just because a strategy has performed well in the past, doesn’t mean it will in the future. We should always keep this in mind, and in the current low interest rate environment it’s been mentioned even more for the 60/40 strategy. Figures in this article are correct to 30/06/2021 (Lipper IM).

Why are there doubts over the outlook for the 60/40 portfolio?

For one thing, both shares and bonds have performed well in recent years. Over the past ten years global shares have risen by 214.9%, while global bonds have returned 40.4%. Now, shares and bonds arguably offer less value. Current bond yields give an indication of their future returns, so today’s low bond yields suggest lower returns from this point in time.

There are more concerns for bonds as the economy is different than it used to be. Bond prices have benefitted from falling yields since the early 1980s, and from big money printing programmes since the 2008 global financial crisis. But with interest rates around the world at record lows, there’s little scope for rates to fall further. And with inflation expectations rising, they’re more likely to rise at some point. This could push down the prices of bonds.

At the same time, borrowers have tended to issue more long-dated bonds, to take advantage of low interest rates and the demand from investors like pension funds needing to match lengthy pension liabilities. This makes bond prices more sensitive to changes in interest rates, so losses could be bigger when interest rates rise.

With yields so low for most government bonds, they offer little income as compensation for the risk taken by lenders (buyers of bonds). Other types of bonds like investment grade and high yield bonds issued by companies, or emerging market bonds, offer higher yields but are higher risk and can lose more in times of stress.

Another possible cloud on the horizon for the 60/40 portfolio relates to diversification. Developed market government bonds, like US Treasuries and UK gilts, have generally behaved differently to shares, providing stability to a balanced portfolio when stock markets fall. Historically this relationship has been one of the keys to the success of the 60/40 portfolio.

However, there’s some debate on whether government bonds will complement shares as well as they have done in the past. Sometimes bonds and shares perform similarly. If monetary policy tightens, such as higher interest rates by making borrowing more expensive, both shares and bonds could lose money at the same time.

It’s not all doom and gloom

Bonds are a diverse investment class, and active fund managers can use different tools to help navigate changing market conditions. For example, Strategic Bond funds are flexible, and many managers aim to make money or provide some shelter to investors’ wealth whatever the direction of bond markets.

Some investors also go beyond shares and bonds and include alternatives – like property, infrastructure, gold and other commodities – in their portfolio. But while this can add diversification, it can add cost and complexity. It can also potentially reduce liquidity, which is how quickly the investments can be turned to cash.

What else do investors need to remember?

Keeping a set mix of different types of investments does involve a few pit stops along the way. Investors should periodically check in on the balance they have and rebalance things where needed. For example, if shares do well, they’ll make up more than 60% of your investments. So you’ll need to sell shares and buy more bonds to bring you back to the 60/40 target mix.

While you can invest in shares and bonds directly, lots of investors invest in funds. Funds invest across a diversified range of shares or bonds on their behalf. An active manager will rebalance the fund themselves to make sure they have the right mix of investments. But that doesn’t mean you don’t have to check in on your investments. You’ll still need to rebalance them where needed – you just won’t have to do all the heavy lifting by yourself.

You can even invest in a mixed-asset fund. That’s where the manager chooses the mix of investments for you. Some mixed-asset funds stick quite closely to a set mix of shares and bonds, while others change the mix in response to how the stock market’s doing and their outlook.

What does all this mean for investors?

Regardless of the outlook, the concept of 60/40 isn’t right for everyone. The right mix depends on an individual’s objectives, and attitude to risk. Investors looking for a higher return and willing to take on more risk, might invest more in shares, and vice versa.

Of course, we don’t know what will happen in the future or if a 60/40 or similar portfolio will offer the best approach. But this uncertainty is the very reason that a diversified portfolio is so important – we don’t know how different investments will perform, and when. And despite the questions, government bonds should still offer diversification against the risks of shares in times of stress.

Diversification - the investor's tool we all need to talk about

We think a well-diversified portfolio should include a mix of different investments, such as shares and bonds, as well as a range of geographies and investment styles. Investing in lots of different stock markets and sectors around the world can offer more opportunity, as well as greater diversification.

Mixed-asset funds provide a convenient way to help diversify. You can match how much risk you’re comfortable with to how much a fund invests in shares.

The Mixed Investment 0-35% Shares and 20-60% Shares sectors could make up the more cautious part of a portfolio.

Funds in the Flexible and 40-85% Shares sectors tend to be used for looking for higher gains, but come with more risk of ups and downs along the way. Some Flexible funds invest less in shares though, so it’s worth checking the aim and investment mix of each fund before you invest.

This article isn’t personal advice. Investments will rise and fall in value, so you could get back less than you put in. If you’re not sure what’s right for your circumstances, ask for financial advice.

Take a look at the mixed investment funds we have on our Wealth Shortlist.

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