What is a 60/40 Portfolio?
There are many styles of portfolio you can build for yourself. The style of your portfolio can reflect your risk tolerance when it comes to investing. A 60/40 portfolio traditionally means you may be slightly risk-averse and so have 40% of your portfolio in bonds.
What is a 60/40 portfolio?
The 60/40 portfolio is one of the simplest strategies when investing in the market. Smoothing returns and avoiding losses have been crucial to investors which is why many adopted such a strategy.
The 60/40 represents the weightings between equities and bonds, with 60% of the portfolio being equities taking advantage of the good returns that the stock market brings. Then the other 40% is represented by bonds. Having such a high percentage of bonds smooths out the ride of the stock market for the investor. Not only the troughs but also the peeks, having the portfolio set up this way lowers the Beta for the portfolio.
Schroder’s calculations show that investments, over the last 30 years, based on a 60/40 strategy, would have been effective both in terms of smoothing out volatility on top of that giving the investor impressive returns.
The example Schroder uses is where stocks are represented by the MSCI World total return index (global developed markets) and bonds by benchmark 10-year treasury bonds.
*Returns have not been adjusted for inflation or trading costs.
Like most portfolios they need rebalancing, the frequency of rebalancing varies and comes down to the investor themselves, though it’s quite common to rebalance yearly.
The reason, especially for the 60/40 portfolio is that in a particular year one of the others (Equities or Bonds) may have a very good year in terms of returns.
If either one starts representing a far bigger percentage of your portfolio than allocated, you could end up with a portfolio weighted towards one asset. This will leave you with a greater risk exposure than you may like.
If curious about how or when to rebalance your portfolio check out our article which goes into more information.
Does the 60/40 strategy still work?
Over the last decade, the 60/40 portfolio could have returned 7.5% annually, much better than a bank!
The drawback recently (as of 2020-2021) is the record low-interest rates and other policies employed by central banks have distorted returns and overall have reduced the returns on government bonds.
For example, bonds-only investment, since 2008 would have returned just 2.5%. This compares with a stocks-only portfolio which would have returned 10.3%.
The low-interest rate environment alongside central bank intervention has reduced bond yields and pushed investors into riskier assets in the search of higher returns.
Claire Walsh, Schroders Personal Finance Director, said while the 60/40 rule may not have provided the returns investors may have desired in recent years it imbues them with investment discipline.
“As the data shows, the 60/40 rule could still achieve a decent return but since the introduction of low-interest rates, from the time of the financial crisis, it has been less effective. However, there are still benefits in this approach.
“For instance, using the 60/40 rule and regularly rebalancing could prevent you from making classic investment errors, such as panic buying and euphoric selling. Much like saving on a monthly basis, regular rebalancing teaches you to be disciplined with your investing.
“Arguably the real benefit of the 60/40 rule is psychological. Fluctuating markets is distressing. Rebalancing can give investors greater peace of mind. It can help them avoid the temptation to fiddle too much with their investments and stop them from selling at the bottom (because things are bad) and buying at the top.”
Creating a 60/40 Portfolio
An extremely easy way to create the 60/40 portfolio with one of the most hands-off methods is the Vanguard life strategy 60% equity fund. This is exactly how it sounds with 60% of the portfolio being made up of equities and the other 40% bonds. Having one fund also makes it much easier as you, the investor, won’t have to worry about rebalancing the portfolio as that is taken care of for you with this fund.
If interested in the Vanguard Lifestrategy 60% equity fund, click here.
If you don’t have access to such a fund another way is to select your own ETFs to create the portfolio.
A good balance would be needed to diversify across the world so Vanguard FTSE All-World ETF (VWRP) is a good ETF for the UK investor. That taking care of the equity side of the portfolio we could look into the bonds. There are many bond ETFs out there that can come down to the investor in how diverse they want to be.
|Vanguard FTSE All-world||VWRP||Equity||60%|
|Vanguard UK Gilt||VGOV||Bond||15%|
|Vanguard US bond||VUTY||Bond||15%|
|Vanguard Aggregate bond||VAGP||Bond||10%|
If this style of portfolio interests you then check out the types of accounts you can use the 60/40 portfolio style in by checking out our article on the 4 types of investment accounts.