No Longer the Benchmark: Why It's Time to Rebuild the Traditional 60/40 Portfolio

For more than seventy years, the classic 60/40 allocation—60% stocks and 40% bonds—served as the benchmark for the balanced investor. But after 2022, the situation changed, writes Boris Kozhukhovsky, a financial advisor at LK Finance LLP, in a column for Oninvest.

It is generally accepted that this idea originated in the early 1950s thanks to Harry Markowitz, his book *Portfolio Selection*, and Modern Portfolio Theory.

This portfolio is based on the principle of diversification across two assets with different levels of risk and expected returns. Historically, stock and bond prices have generally moved in opposite directions. Roughly speaking, when stocks fell, bonds rose. Therefore, the 60/40 portfolio has historically been considered a balanced approach, based on the ability of bonds to offset declines in stocks and mitigate losses during periods of market volatility.

According to Morningstar, during the Great Depression, when the market fell by 79%, a 60/40 portfolio would have declined by 52.6%. During the 1970s, when the U.S. market fell by 51.9%, this portfolio declined by 39.4%. During the Lost Decade (2000–2010), the stock market fell by as much as 54%, while the 60/40 portfolio declined by only 24.7%. In other words, it fulfilled its primary purpose—protecting total value during stock market crises. And although the 60/40 portfolio’s growth potential is significantly lower than that of a portfolio consisting solely of stocks, the depth of inevitable market downturns will be much less severe.

And this principle has been in effect for over 100 years.

The year 2022 served as an example of a positive correlation: the stock and bond markets fell simultaneously, revealing the 60/40 model’s vulnerability in providing effective diversification during severe market downturns.

According to BlackRock, the macroeconomic environment that has supported this asset allocation strategy in recent years has changed. A more complex environment, characterized by high inflation, policy uncertainty, and more frequent supply chain disruptions, has challenged the traditional factors that determine the effectiveness of the 60/40 strategy. These circumstances have led to lower returns and higher volatility compared to the previous decade.

According to BlackRock data, under the “old system” from 2012 to 2022, the average return on a 60/40 portfolio was 11.42%, with volatility of 7.91%. After 2022, over the past three years, the return on a classic 60/40 portfolio was 6.7% with a volatility of 11.63%.

A key challenge for the portfolio has been the weakening of the correlation between stocks and bonds, which historically has contributed to diversification. Today, the situation is shaped by ongoing disruptions in supply chains, including the pandemic and subsequent geopolitical events, which have contributed to rising energy prices and increased price pressures overall.

Supply disruptions can have the opposite effect: bond prices fall and yields rise in response to price pressure, reducing their ability to provide diversification. Since inflation consistently remains above the target level, central banks’ ability to lower interest rates is significantly reduced, even despite stock market declines in response to these shocks. As a result, bonds have proven less effective at providing diversification during periods of stock market stress.

Episodes of renewed inflation concerns have led to simultaneous declines in both asset classes, a recent example being the oil shock in Iran.

As traditional 60/40 portfolios face challenges, the need for diversified sources of returns has increased.

The 60/40 model is fundamentally based on the use of trend-following market factors; in other words, its returns are closely tied to the ups and downs of the broader market.

One way to diversify—beyond simply focusing on the direction of investments—is to generate returns by capitalizing on relative differences that arise within and between markets. Such strategies allow for investments in both long and short positions, derivatives, or market-neutral investments, as well as liquid or illiquid alternative assets.

This additional component should be designed to have a low correlation with traditional stock and bond portfolios, making such strategies complementary and diversifying within portfolios.

For example, long/short strategies aim to identify fundamental differences between securities regardless of the market’s direction. Market-neutral strategies can further contribute to diversification and enhance the stability of returns, especially in falling markets, when this is most important.

Factors such as the adoption of artificial intelligence and a more complex macroeconomic environment are leading to greater divergence in companies’ financial results. Divergent inflationary and political strategies are contributing to an uneven global environment, creating opportunities for macro strategies to capitalize on these differences across countries and asset classes.

A BlackRock study comparing traditional stock and bond portfolios with portfolios that include 20% liquid alternatives showed that, at a risk level similar to that of a traditional 60/40 portfolio, the inclusion of 20% liquid alternative investments increased returns from 6.7% to approximately 9.2%. Conversely, for a similar level of return, volatility decreased from 11.6% to approximately 9.3%.

These results highlight a significant shift in portfolio construction. In the face of recurring shocks, when diversification has become less reliable, incorporating alternative sources of income can broaden the range of opportunities and enhance the portfolio’s resilience.

Rather than replacing the traditional 60/40 model, these strategies can enhance it by incorporating new factors that are less dependent on market direction and better complement existing investments in stocks and bonds. In this way, they can help restore diversification and enhance the stability of returns across a wider range of market conditions.

In recent years, BlackRock, J.P. Morgan, and Morgan Stanley have launched lines of similar products in the form of ETFs that employ alternative strategies. An important factor is that all of these alternative investments are liquid, transparent, and accessible to individual investors, even those with small portfolios.

This is not an investment recommendation.

This article was AI-translated and verified by a human editor