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Bonds and 60/40

2022-08-01, Michael Thompson

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Bonds and 60/40

The last 12 months have been a challenge for 60/40 and bond investors. While the US stock market, as measured by the VTI ETF, has fallen over 12%, most bond funds have shed as much or more than stocks. Vanguard’s total bond market fund BND has fallen 12%, and the 20-year treasury bond ETF TLT has fallen 20%! Bonds haven’t provided the ballast that investors hoped for. To make matters worse, bonds provided pitiful returns in the prior years when stocks were booming. The bond funds mentioned are cheaper now than they were 5 years ago!

Looking further back, before recent history, bonds did play a diversification role in portfolios. Bond price volatility was much lower than stocks, and bonds often (not always) appreciated as stocks lost value. For this reason, so-called 60/40 portfolios—with 60% stocks and 40% bonds—were widely used. People with more money or a higher risk tolerance would concentrate more in equities, but 60/40 was a rough guidepost.

Motivated by more recent performance, many investors have asked about reducing or eliminating bonds from their portfolio, perhaps changing this guidepost to 80/20. Let's see what various people and institutions think about reducing bond holdings.


Roger Aliaga-Diaz, Vanguard’s chief economist for the Americas, says the 60/40 portfolio isn’t dead. He maintains that investors should keep their eye on the long-term, where 60/40 is meant to provide 7% annual gains on average. "Brief, simultaneous declines in stocks and bonds are not unusual," he wrote in a commentary. "Viewed monthly since early 1976, the nominal total returns of both U.S. stocks and investment-grade bonds have been negative nearly 15% of the time."

"Extend the time horizon, and joint declines have struck less frequently," Aliaga-Diaz said. "Over the last 46 years, investors never encountered a three-year span of losses in both asset classes." "During 2019–2021, a 60-40 portfolio delivered an annualized 14.3% return, so losses of up to 12% for all of 2022 would just bring the four-year annualized return to 7%, back in line with historical norms."

What do Vanguard retirement funds indicate about this? Vanguard’s 2035 target date fund VTTHX is about 71/29 stocks/bonds at the time of this writing, while their 2045 target date fund VTIVX is 86.5/13.5. These funds do not omit bonds, but they are more aggressive on stocks than a traditional 60/40. Of course, the longer the time horizon, the smaller the bond concentration in these funds.

Bank of America

Bank of America published a research note back in 2019 called “The End of 60/40” in which they said “there are good reasons to reconsider the role of bonds in your portfolio.” This was based on the premise that interest rates were historically low and likely to rise, devaluing lower rate bonds. Soon after, however, COVID hit and interest rates fell further. (Another example of a blatant failure to predict macroeconomics.) From today’s POV, however, the prediction was right—climbing interest rates have crushed bond funds.

The real question is whether the argument applies moving forward. Interest rates are higher, and expected to increase more in the short term, but what will they be 12 months from now? Warren Buffett once said not to make investment moves based on economic predicitons, and I think that’s the right idea. Expert economic predictions seem to be wrong more often than they are right, regardless of the experience, smarts, or hardwork backing them. When I’ve invested based on such predictions I’ve actually done worse!

Goldman Sachs

Goldman released an article in October 2021 titled “Is the 60/40 Dead?”. They point out the consensus view that typical investment returns over the coming decade will likely be low due to high stock valuations and low interest rates. Their conclusion: “we think investors have many reasons to be concerned that the 60/40 might be dead” appears to be based on an opinion that investors should shift to more uncommon, higher risk, investments to boost income in such slow times. Specific investments mentioned by GS included: global real estate, high yield municipal bonds, emerging market debt, and global high yield bonds and infrastructure.

Some have argued this logic of shifting to riskier investments in tough times is backward. It does seem to miss the important fact that 60/40 specifically aims at reducing volatility and providing some safety in rough times. GS may claim that, by diversifying across many of the alternate investments they suggest, volatility and risk will be low. This should be scrutinized though—there are many events (like the pandemic) that could trigger large downswings in most of these assets simultaneously.

Warren Buffett

As far as I know, Buffett has never supported a 60/40 portfolio, at least for high worth individuals. In a 2013 Berkshire shareholder letter, he stated that his wife’s inheritance would go 90% into a low-cost stock index fund and 10% into short-term government bonds. This doesn’t mean he thinks it’s a good idea for everyone. That inheritance is so large enough that the 10% bond portion could easily fund her retirement, and there would be no need to liquidate stocks in a bad market. The average person, with much less money, would be more likely to get into trouble with such a portfolio.

Morningstar’s Amy Arnott

Morningstar’s Amy Arnott said that, although bonds have moved similar to stocks this year, they “still have some significant benefits for risk reduction.” Diversification with bonds “is like an insurance policy, in the sense that it has a cost and may not always pay off,” she said. “But when it does, you’re probably glad you had it,” Arnott added.

Final Thoughts

It seems stock and bond markets have recently been overly sensitive to interest rates: when rates drop both stocks and bonds rise, but when rates increase stocks and bonds fall. The diversification benefit of bonds hasn’t panned out recently. However, let’s not forget that there’s more to asset prices than interest rates. There are many events that could drive down stock prices substantially more than bonds.

It’s also true that interest rates are low and stock valuations are high. They’ve improved in recent months, but still bad compared to long -term averages. This does indicate lower returns are likely for the next decade. Some opinions above stressed reaching out to new and riskier investments to counter this. This may be prudent for some investors, but they should realize the risks they are taking.

Recency bias says people are overly influenced by recent history. Although not true recently, including a substantial amount of bonds in a portfolio has averted overall large downswings most of the time. This is important because such downswings can and do cause some investors to panic and drop out of the market (at bad times), severely reducing long-term gains.

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