Assessing Bonds: Is the 60/40 Rule Still Relevant for Retirement Savings?
The 60/40 rule has long been a cornerstone of investment strategy, suggesting that investors should allocate 60% of their portfolio to stocks and 40% to bonds.
While stocks can offer high returns, they are also known for their fluctuations. Bonds, in contrast, typically provide steady but lower returns and can help cushion your investments during stock market downturns.
This 60/40 strategy is a well-known guideline in personal finance. However, recently, many in the investment sector started to doubt its effectiveness.
Throughout 2023 and early 2024, many articles and discussions questioned the viability of the 60/40 portfolio, debating whether it’s still a suitable strategy for maintaining a balanced investment approach and suggesting alternative options.
The skepticism stemmed from the challenging year of 2022, where bonds experienced one of their worst performances ever, severely impacted by soaring inflation and increasing interest rates.
As 2024 comes to a close, though, investors are beginning to reconsider the 60/40 approach.
Is the 60/40 Rule Still a Good Guide for Investors?
In a recent analysis, Vanguard reaffirmed that the 60/40 strategy remains “a solid starting option for long-term investors, and this is as true today as it has ever been.”
Other financial experts echo this sentiment.
“The 60/40 ratio continues to serve as a reliable benchmark for a well-rounded portfolio,” stated Jonathan Lee, senior portfolio manager at U.S. Bank.
Todd Jablonski, global head of multi-asset investing at Principal Asset Management, believes the 60/40 rule is still “very much alive,” jokingly adding it could be compared to a Mark Twain quip.
The 60/40 rule is based on the widely accepted notion that a diversified investment portfolio is crucial, especially as retirement approaches.
On average, stocks can yield returns of around 10% annually, significantly exceeding what one would expect from a typical savings account. However, stock markets can be unpredictable and may decline sharply during economic downturns.
Bonds are typically viewed as secure and stable investments: the ideal counterbalance to stocks. In theory, when stock prices fall, bond values increase.
The ‘Boring’ Bonds Disrupted in 2022
The market was significantly impacted in 2022, leading to dramatic changes. The S&P 500 index saw a drop of 18.6%, while bonds experienced a decline of 13.7% according to the Vanguard Total Bond Market Index. Following inflation adjustments, this was the worst performance for bonds in 97 years, as per a NASDAQ analysis.
This devastating bond market performance raised doubts for many investors about the necessity to rethink retirement strategies, starting with the 60/40 rule.
The decline in bond values was primarily due to the Federal Reserve’s aggressive interest rate hikes in response to soaring inflation, which hit a 40-year peak.
This scenario hurt bonds because rising rates typically lead to decreased values for bond funds, and higher inflation diminishes the purchasing power of bond returns.
As interest rates go up, newly issued bonds offer better yields, making existing bonds with lower yields seem less appealing, ultimately pushing down their market value.
Additionally, inflation makes it even less desirable to hold bonds. For example, if a bond has a 4% return and inflation is 5%, then the real return becomes negative.
Even before 2022, the performance of bonds was underwhelming, with historically low interest rates throughout the post-2008 period, stemming from the Great Recession and later the COVID-19 pandemic. When rates are low, investors tend to earn less from bond investments.
“Investors began to wonder how much lower bond values could go,” noted Jablonski.
The 60/40 landscape is different in 2024
Today’s bond market has changed significantly. Inflation has decreased. Though interest rates are still relatively high, they are on a downward trend, resulting in new bonds offering attractive returns.
Investors adhering to the 60/40 rule are seeing satisfactory results.
According to Jablonski, the 60/40 portfolio experienced a 15.8% decline in 2022. However, in 2023, it rebounded with a 17.7% increase, and as of November 6 this year, it has gained 15.5%.
“That’s a pretty good level of return,” he noted.
When considering the poor performance in 2022, Vanguard’s data indicates that over the past decade, the 60/40 portfolio has averaged an annual gain of 6.9%.
“The last ten years have been strong for the 60/40 portfolio, as stocks have performed exceptionally well,” said Todd Schlanger, senior investment strategist at Vanguard and author of the October report.
Now, with stock markets thriving, investors should prepare for potentially slower stock growth in the upcoming years. By historical measures, the stock market appears to be overvalued.
Consequently, “the returns for 60/40 are likely to be lower than those seen over the past decade,” Schlanger explained.
However, bonds should not be held responsible.
“Bonds are expected to provide a more significant contribution over the next 10 years compared to the last decade,” Schlanger stated.
Currently, the yield on the benchmark 10-year Treasury bond stands at about 4.3%, according to CNBC. This yield represents the annual interest rate investors can earn throughout the bond’s lifespan. Right now, yields are surpassing inflation.
“People are starting to favor bonds as interest rates have risen,” Lee mentioned.
Bond yields are rising along with the deficit
One factor contributing to high bond yields, especially for long-term bonds, is investor concern over the federal government’s increasing debt.
The interest rate on a 10-year Treasury note reached its highest in months on Wednesday, following the news of Donald Trump winning a second term as president.
Trump’s campaign was centered on tax reductions. Economists are forecasting that Trump’s tax policies will exacerbate the federal deficit, which currently stands at $1.8 trillion.
“The market risks under Trump include a lack of fiscal discipline. By 2025, the deficit is expected to dominate market discussions,” stated James Camp, managing director of fixed income and strategic income at Eagle Asset Management in St. Petersburg, Florida, in comments to Reuters.
Bond yields are on the rise partly because investors are sensing a greater risk that the government may be overspending, according to Jablonski.
This situation reinforces a fundamental principle of finance: entities with lower creditworthiness must offer higher interest rates, even if that entity is the government.