The 60/40 stock and bond portfolio is not dead, so advisors should not try to kill it or bulk up on higher yielding, riskier fixed income assets, according to Vanguard investment consultant Matthew Sheridan.
At a recent webinar hosted by Dave Nadig, chief investment officer and director of research at ETF Trends, Sheridan, who works with financial advisors, compared a 60/40 stock and bond portfolio to the typical advisor portfolio of 60% stocks, 30% bonds and 10% cash to lower the duration, or interest rate sensitivity, of the portfolio as rates rise.
The cash is usually paired with a U.S. home bias and relative overweights in small-cap stocks, short-term credit, high-yield bonds and emerging market debt, Sheridan said. More recently, the fixed income allocation includes less liquid but higher yielding assets like bank loans and convertibles, which have higher yields than other fixed assets, according to Sheridan.
Looking forward over the next 10 years, the Vanguard model shows almost the same annualized return for the two portfolios — around 4.08% — but the typical advisor portfolio has a lot more volatility — 10.11% vs. 9.20%. The primary reason is client behavior in response to the more volatile portfolios, Sheridan said.
Stocks vs. Bonds During Downturns
He also looked back at the performance of stocks and bonds during the double-digit stock market downturns that occurred in the fourth quarter of 2018 and the first quarter of 2020. In both downturns, U.S. and non-U.S. investment-grade bonds appreciated, while U.S. and non-U.S. stocks and U.S. high-yield bonds lost value.
"We do not believe the 60/40 portfolio is dead at this point. There are periods when equities fall 4%, 5%, 7% and bonds might move off, but when equities drop 20% or 30%, that's when … having allocation to investment-grade credit or government bond credit will play a solid role in portfolio construction moving forward."
