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The 60/40 portfolio – a cornerstone strategy for the average investor – has been weighed down by pandemic-era economics and market dynamics.
“However, the 60/40 portfolio is certainly not dead,” Holly Newman Kroft, managing director and senior wealth advisor at asset manager Neuberger Berman, said Thursday at the semi-annual CNBC Financial Advisor Summit.
Although it is not dead yet, “it needs to be modernized,” she added.
The strategy invests 60% in stocks and 40% in bonds – a traditional portfolio that carries moderate risk.
More broadly, “60/40” is a shorthand of sorts for the broader topic of investment diversification.
Bonds are thought to act as ballast when stocks – the growth engine of a portfolio – perform poorly because they often do not move in lockstep.
Generally, the classic 60/40 mix is considered to include US stocks and investment grade bonds such as US Treasuries and high-quality corporate bonds.
By 2021, the 60/40 portfolio had performed well for investors.
Investors achieved higher returns than those with more complex strategies in each recent three-year period from mid-2009 to December 2021, according to a study analysis Written last year by Amy Arnott, portfolio strategist at Morningstar.
However, things have changed.
In 2022, inflation skyrocketed, reaching a peak not seen in four decades. In response, the Federal Reserve aggressively raised interest rates, hurting stocks and bonds.
Bonds have historically served as a shock absorber in a 60/40 portfolio when stocks decline. But this defense mechanism has broken down.
How to rethink the 60/40
This dynamic – stocks and bonds moving more in lockstep – is likely to continue for a while, Paula Campbell Roberts, chief investment strategist for global wealth solutions at KKR, said at the summit.
While the Fed is unlikely to raise interest rates much higher (if at all), officials have already signaled that they will It is unlikely that interest rates will be reduced any time soon.
And there are some risks for U.S. stocks going forward, experts said. For one thing, while the S&P 500 is up 14% this year, those gains concentrated in just 10 of the largest stocks, Roberts said.
However, investors also benefit from higher interest rates because they gain “access to safer, higher-yielding asset classes,” Kroft said. For example, banks pay 5% to 5.5% on high-yield cash accounts, and municipal bonds pay a tax-like yield of about 7%, she said.
The Fed’s “higher for longer” mentality means bonds should have those equity-like returns over a longer period of time, Kroft said.
So what does this mean for the 60/40 portfolio? On the one hand, this does not mean that investors should sell their shares, said Kroft.
“You never want to get out of the asset class,” she said.
However, investors could consider replacing a portion – perhaps 10 percentage points – of their 60% equity allocation with so-called alternative investments, Kroft said.
That would likely increase investment returns and, given the typical characteristics of “alternatives,” reduce the risk of those assets moving in tandem with stocks, Kroft said.
Within the alts category, high-net-worth investors can access certain things like private equity and private credit, Kroft said. The typical investor can access alternatives through more liquid funds – such as a mutual fund or exchange-traded fund – that focus on alternatives, or through commodities-focused funds, she added.
She warned that wealthy investors seeking private equity need to be “very careful” in choosing their asset managers because the performance gap between high-performing and mid-market companies is “huge,” Kroft said.
For bonds, investors who hold bonds with a short maturity may consider extending that maturity to lock in higher returns for longer, she added.