The 60/40 portfolio was once the gold standard for buy-and-hold investors. This easy formula offered the allure of strong annual returns with ample downside protection. However, in today's changing market, there are many reasons why the 60/40 portfolio might no longer meet investors' needs.
What Is The 60/40 Portfolio?
In a 60/40 portfolio, 60% of the investments are allocated to stocks and 40% are allocated to bonds (often low-risk government bonds). This portfolio was attractive to investors for several reasons. Apart from its simplicity, it promised the benefits of diversification and lower volatility. In theory, bonds and stocks are negatively correlated, meaning the price of bonds rises when the price of equities falls. The 60/40 portfolio has also historically delivered attractive returns. According to Vanguard, a 60/40 portfolio delivered an average annual return of 8.8% between 1926 and 2019. Since 1980, the compound annual growth rate has been higher, at 10.2%.
However, there are several reasons it might be time to rethink the traditional 60/40 portfolio.
• Treasury yields are at an all-time low. U.S. Treasury yields have been at an all-time low for the past 10 years. This ultra-low interest rate environment is not going away any time soon, as the Fed has repeatedly committed to keeping rates low for the foreseeable future. As of February 25, the yield on the 10-year Treasury was 1.54%, which remains below the rate of inflation. What this means for buy-and-hold investors is that bonds are no longer a reliable source of income, and portfolios with a significant bond allocation will likely fail to produce meaningful returns.
Put The Power Of Prediction In Your AIOps
• Investors should position themselves for rising inflation. While inflation has been virtually nonexistent since the Great Recession, that may change soon. BlackRock recently warned investors that a combination of macro factors, including rising production costs as global supply chains realign and relaxed central bank policies, could lead to a rise in inflation in the medium term. Inflation is bad news for fixed-income investors. First, it leads to an increase in bond yields, which drives down the valuation of an existing bond portfolio. Second, inflation eats into real returns.
• Bonds and stocks don't provide enough diversification. Although stocks and bonds have been negatively correlated over the past 20 years, Bank of America noted that this is a recent phenomenon and one that may change in the near term. Derek Harris and Jared Woodard, portfolio strategists at BofA, note that the 60/40 portfolio is built on the premise that stocks and bonds are negatively correlated with bonds hedging against risks to growth and stocks hedging against inflation. But, they explain, "this assumption was only true over the past two decades and was mostly false over the prior 65 years. The big risk is that the correlation could flip." The takeaway for investors is that diversification requires thinking beyond just stocks and bonds.
Alternative Strategies
Fortunately, investors today have many options for achieving more diversification and helping to improve the returns of their portfolios.
First, several asset classes offer many of the benefits of government bonds with slightly more risk. Corporate debt offers slightly better returns, although returns are directly correlated with credit risk. Preferred shares also offer fixed payments similar to bonds, although companies have the ability to suspend the dividend and preferred shareholders have a lower priority on cash flow than bondholders.
Another option for investors is to increase their allocation to equity. Additionally, for investors in search of income, many stocks offer a higher dividend yield than the current yield on bonds. However, many metrics indicate that the stock market may be overvalued, meaning that investors who put too much money into stocks risk big losses when the market crashes.
A third option is alternative investments. Alternatives offer several benefits: They are generally uncorrelated with stocks and bonds, which improves portfolio diversification; they tend to be less volatile than publicly traded assets; they have the potential to provide more attractive returns; and many alternatives offer other benefits, such as passive income.
The more commonly known alternatives take the form of gold and silver, real estate and commodities. Precious metals, and gold in particular, can offer a hedge against market downturns. Real estate values, particularly in high-demand areas, can net investors superior gains compared to that of Wall Street. And commodity prices tend to stay consistent so long as supply and demand are balanced; when inflation strikes, agricultural prices tend to increase. Like all assets, these come with risks. The price of gold has been historically volatile, making this asset less appealing for investors with a low risk tolerance. Real estate can be fickle depending on location, when you invest, etc., and commodity prices fluctuate with changes in consumer demand and oversupply.
A less well-known alternative, farmland (my area of focus), is a low-volatility asset class that is uncorrelated with the performance of stocks and bonds, making it a good way to both increase portfolio diversification and reduce overall portfolio volatility. With farmland, investors have two sources of returns: periodic payments from rent and the sale of crops and price appreciation when the asset is sold. Its risks generally involve liquidity and education. An investment is generally illiquid until exit (such as selling the farm). In addition, while farmland is technically the oldest asset class around, it's relatively unknown to many investors. As a result, many investors are forced to place their trust into the platforms through which they're investing, and approach this asset class with imperfect knowledge.
Are You Ready To Move Beyond The 60/40 Portfolio?
If you're interested in improving your returns while reducing risk, alternative assets and strategies can help take your portfolio to the next level.
This article originally appeared on Forbes.
