Portfolio considerations
July 25, 2023
Our article on the improved outlook for the 60/40 portfolio generated much interest from readers, but the questions our strategists fielded also made it clear that there are many misconceptions surrounding this tried-and-true investment standby. Here, we set the record straight.
“The misconceptions seem to fall into three broad themes,” said Todd Schlanger, a senior investment strategist. “Two of them deal with execution, but one is fundamental—basically defining what 60/40 is.”
60/40 is a proxy for the typical balanced portfolio, not one-size-fits-all.
“The 60/40 is that middle-of-the-road portfolio that reflects the typical investor’s asset allocation, so it’s often used as an example in industry research,” Schlanger said. “It’s a good proxy because many institutions have historically used this allocation to meet their objectives. Further, if you look at the most popular products for individual investors, such as target-date funds, the average asset allocation is right around 60/40. So it’s a good proxy for individual investors as well.
“But that’s not to say that 60/40 is any better than a 40/60 or 90/10 portfolio for investors who need a more conservative or more aggressive portfolio for their goals, time horizon, and risk tolerance. In other words, 60/40 is not the best choice for the average twenty-something with a 60- or 70-year time horizon. They would likely benefit from more equities to grow their portfolio over the long run. It’s a good starting place, but an investor will need to tailor a portfolio to their needs.”
There is more than one way to implement 60/40.
The strategy has evolved over time to include additional asset classes.
“The average 60/40 portfolio used to be just U.S. stocks and bonds, but non-U.S. assets have become commonplace over time as access and costs for investing in them have come down,” Schlanger said.
And there’s ample room for customization in such a portfolio.
“A case can be made that alternative investments—commodities, private equity, and so on—can enhance a portfolio’s risk-return profile,” Schlanger said. “But they are not for everyone, and you have to weigh the potential benefits against the typically higher costs, complexity, and illiquidity associated with some of those assets.
“If you invest the bulk of your retirement money in core asset classes and modestly overweight certain sectors or actively managed funds that you believe can add value over the long term, that approach is valid.”
Vanguard Wellington Fund, founded in 1929, is an example of this approach, though its actual asset allocation is closer to 65/35. The fund tilts toward value stocks and corporate bonds with the goal of adding incremental alpha over time.
60/40 is not “set it and forget it."
The simplest way to implement a 60/40 portfolio is through a single fund option because you won’t need to rebalance it over time—that’s done by the fund’s portfolio manager.
But you may have opted for multiple funds in a model portfolio. Or, even if you’re in only one fund, the asset allocation may no longer be appropriate as time passes. In either case, Schlanger said, you should periodically revisit the portfolio to:
- Reassess your situation to determine whether the asset allocation is still right for you, and if it no longer is, move to a new allocation.
- When appropriate, rebalance the portfolio back to its target allocation.
On the first point, Schlanger said: “Life happens, things change. Your financial situation and goals may have evolved since you first selected that target asset allocation years or decades ago. There’s nothing wrong with changing your investment strategy, as long as it’s driven by careful consideration, not by market noise.”
On the second point, without rebalancing, equities tend to become a larger share of the portfolio over time. Rebalancing reduces overall portfolio volatility by keeping your allocation to equities and other risky assets constant. There are multiple approaches for when to rebalance—calendar-based, threshold-based, or a combination of the two. Vanguard’s research paper on this subject suggests that, for most investors, rebalancing on an annual basis is adequate.
“Whether it’s 60/40 or another asset allocation, rebalancing will help make sure your portfolio is consistent with your risk tolerance,” Schlanger said.
Related links:
- Time to move on from the 60/40 debate (commentary in InvestmentNews, issued June 2023)
- Higher inflation not the end of the 60/40 portfolio (article, published June 2023)
- Vanguard’s economic and market outlook at midyear 2023 (web page with links to economic and market forecasts, issued June 2023)
Notes:
For more information about Vanguard funds, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
In a diversified portfolio, gains from some investments may help offset losses from others. However, diversification does not ensure a profit or protect against a loss.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.Investments in bonds are subject to interest rate, credit, and inflation risk.
Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target date funds is not guaranteed at any time, including on or after the target date.
Contributor
Todd Schlanger, CFA
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