Is the Venerated 60/40 Portfolio Too Risky Right Now?
Much has transpired over the past weeks and months that have investors potentially bracing for a recession. Not only has the Fed started raising interest rates to combat inflation, but the market briefly entered into bear market territory on May 20th, 2022 when the S&P 500 dropped more than 20% below record highs. The market actually finished UP for the day, but if you count this intraday low, we did enter into a bear market. Such sharp intraday swings really haven’t been seen since March of 2020.
Five months of selloffs first began in the tech sector and speculative corners of the market, but recently even consumer staples—which are typically shielded from the turmoil—have taken a hit. The bond market isn’t faring much better with some of the worst bond returns since 1842.
Inflation and the Rising Interest Rates Meant to Combat It
What’s to blame for all the commotion? Most notably, inflation and the rising interest rates being instituted to combat it. Fed tapering has begun and is projected to continue into 2023—or as long as the ballast is needed to stave off inflation.
Up until now, interest rates and inflation have been trending downward for nearly 40 years. Does anyone remember the 12% mortgages at the beginning of the Reagan administration? But now they are on the rise again and changing the landscape for the 60/40 portfolio that investors—especially those with retirement in their sights—have long clung to as a safe allocation mix.
Why Was the 60/40 So Popular for So Long?
The idea behind the 60/40 mix was that the 60% invested in stocks would drive returns while the 40% in bonds would provide a hedge against volatility. Together, this mix of assets would form the core building blocks of a relatively conservative long-term portfolio—one that could capture upside potential but protect from downturns.
The 60/40 has had a good run, generating positive returns in 11 of the past 12 years. But this same portfolio that provided a “safe” mix just two years ago is significantly more risky in today’s rising rate environment.
How Rising Rates Affect the 60/40 Portfolio Mix
Today, because both stocks and bonds are reacting poorly to rising inflation and interest rates, the 60/40 portfolio posted losses in September, November, and December of 2021. Since then, there have been simultaneous instances of losses in both large-cap stocks and government bonds, indicating that the 60/40 could be in for more trouble ahead.
Essentially, the prospect of higher interest rates makes it difficult for bonds to maintain their defensive hedge. And with bonds yielding less than the inflation rate, investors may start to abandon high-quality bonds for high-yield bonds, driving prices down further. Of course, investors will still be searching for higher yield, in which case they’ll likely pour back into equities; but, equities are also under pressure from rising rates and may remain under this same duress for some time into the future.
The Importance of Diversification
In this environment, some may argue that it doesn’t make sense to hold bonds at all given record-low interest rates and the Fed’s plans to continue tapering. Why not allocate all your funds to high-yielding classes?
The answer for long-term investors is simple and remains the same answer we give in bull markets, as well: diversification.
Managing portfolios for long-term success isn’t about reaching for yields, but rather for protecting against too much risk or making a costly mistake when markets get rough. That means constructing portfolios that can generate some upside in a multitude of market environments and having the personal restraint to weather the storms as they come.
The Sum of the Portfolio is Greater Than Its Parts
A well-diversified portfolio will likely always contain asset classes that underperform from time to time. But if we can view these classes as falling into a slumber, rather than dying off, and remember that what’s discarded by markets one day can come into fashion the next, it does not make sense to eliminate an entire asset class from the portfolio altogether.
When considering your allocation mix, you must look at how each part contributes to the whole—not how each part acts individually on any given day. Even though the 60/40 may not be the ideal allocation mix for you to hold right now, it doesn’t mean that all prudent investing principles go out the window. What it should mean is that you and your financial advisor take a close look at your near-term and long-term goals and identify which allocation mix will suit you best in this rising rate environment.
WillKate’s Custom Asset Allocation Strategy
At WillKate Wealth Management, we use a custom asset allocation strategy that will keep you on the path toward achieving your goals while not over-exposing you to risk. During periods of market volatility, your portfolio will be adjusted to make sure it stays in balance.
Additionally, our background in life coaching and behavioral finance means we’ll be here to help you tune out the noise and work through emotions and biases so that you can stay confidently on track toward your big picture goals.
If you are unsure of how much risk you are exposed to in this environment, or are looking to partner with a wealth planner who will design and update your custom portfolio with your personal needs in mind, we encourage you to reach out for a complimentary Discovery Call. Let us focus on the intricacies of your portfolio, so you can spend time on the areas of life that fill your bucket – which is what living a well-designed and values-first life is all about.