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Portfolio diversification has always been a major key to investing success. This is exactly why the 60/40 portfolio theory has become so popular over the past 50+ years. But with interest rates remaining near zero, and a broader range of investable assets available than ever before, is it time to rethink this long-held portfolio management strategy?
What is the 60/40 portfolio theory?
Investors are constantly seeking to balance their portfolio among asset classes in order to mitigate risk while achieving optimal returns. One such portfolio consists of 60% stocks and 40% bonds (usually government bonds). For decades, this asset allocation has been a mainstay for investors as it allows for growth through stocks, while keeping portfolio volatility low through bonds, which also serve as fixed income investments.
It’s believed that even during periods of economic contraction, the 60/40 portfolio theory is able to fare well due to the negative correlation between stocks and bonds over recessionary periods.
The case for continued 60/40 allocation
There is something to be said for a time-tested portfolio management strategy. The 60/40 model has performed well for investors over the past four decades while maintaining low levels of volatility. This has been especially important for investors
during periods of economic contraction and recession, where higher-risk portfolios performed poorly.
Bonds still provide the same counterbalance to stocks that they did decades ago. Take the recent coronavirus pandemic as an example. As stocks plummeted in the beginning of 2020, the 10-year Treasury bond generated a first quarter return of 11%. Therefore, a 60/40 portfolio strategy continues to be a prudent way to not only grow wealth, but mitigate risk along the way.
The case for a new portfolio paradigm
It appears we are headed for years, if not decades of low interest rates around the globe. After peaking in the 1980s, the yield on the 10-year treasury has been on a fairly consistent downtrend (as seen in the chart below) for the most recent four decades.
Low rates mean that both government and corporate bonds no longer provide solid fixed income to investors. In a portfolio where bonds continue to comprise 40% allocation, the overall portfolio is likely to underperform as a result, unless stocks outperform to compensate for the muted gains on bonds. Historically, investors had plenty of opportunity in the bond market to yield 5% on their investment, but this is no longer the case. Simply put: bonds aren’t providing the regular, fixed income returns they once did.
Source: https://www.bloomberg.com/graphics/2021-hidden-bond-market-crisis/ Alternative portfolio strategies to consider
Alternative portfolio strategies to consider
As previously stated, low interest rates could continue to see bonds underperform in the coming years. At the same time, investors now view blue chip stocks as a means of fixed income through regular dividend payments. As a result, investors could alter the
60/40 portfolio strategy by allocating more capital into stocks and away from bonds, whether it be at a 70/30, or even 80/20 ratio.
There are also other, alternative assets to consider given the current and future economic outlook. Investments into commodities, precious metals, and even digital assets are all considered possible options for a sound investment portfolio. Diversifying across more asset classes that have higher upside than bonds create the potential for outsized returns. However, it’s important to diversify across these alternative assets so as to mitigate their increased individual risk.
For those seeking to replace government bonds with other fixed income assets, real estate investment trusts (REITs), or even corporate bonds which provide higher returns than their government-issued counterparts, could be better alternatives.
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