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Breaking “Rules of Thumb”: The 60/40 Portfolio Allocation

| January 24, 2022

This post will continue our theme of debunking traditional investing “rules of thumb.” Our post on the 4% withdrawal strategy is an example of past rules busting. In truth, the reason we do these sorts of posts is to highlight our approach to wealth management. Often, it differs from the conventional wisdom – like with the 60/40 portfolio allocation theory.

As we all know, one of the most important pieces of investing is asset allocation. The basic idea is to adjust assets so there’s a diverse portfolio of stocks, bonds, and other assets to help reduce risk and increase returns.

Every reader has probably heard the numbers 60 and 40 before when it comes to investing. They have a special meaning (right up there with your 59 ½ birthday!) Kidding aside, the 60/40 portfolio became one of the most widely used, widely accepted portfolio asset allocation theories out there.

A “60/40 portfolio” is one that holds 60% of its assets in stocks and the remaining 40% in bonds. It was the conventional wisdom. That’s for good reason. For a long time, it worked:

However, as I’ll illustrate, it’s not the case now. The 60/40 portfolio may have hit the end of its usefulness in today's economic and market environment.

Sea Change

Several factors make the 60/40 allocation ineffective now. But I’d like to identify three primary reasons its performance lags:

  1. Low, yet rising interest rates
  2. Inflation
  3. Looser monetary policy

Given these factors, the heavier weight in bonds may not make sense anymore. It forces us to rethink our basic allocation principles. But that can be tough to do with something successful.

At its core, the 60/40 portfolio is easy to understand because of its simplicity. The theory was first popularized in the 1950s. Vanguard founder John Bogle ran with it, making the 60/40 portfolio immensely popular with investors.

For about 50 years, all research and data pointed to that being an optimal allocation. Just look at the chart below. Measured against pure stock and bond portfolios over a 30-year period, the 60/40 allocation smoothed out volatility and provided a better long-term return:

And that strategy made sense…until it didn’t.

We must remember that the potential issue with the 60/40 portfolio lies on the bond side of the ratio. For much of the market’s history, bonds yielded much more than they do today. In fact, bond yields are at some of their lowest points historically, especially from a real rate of return perspective:

The flip side to this was the amazing bull market run in U.S. Treasury bills since the 1980s. For some quick history, since interest rates peaked in September 1981, they have fallen. This has helped push up bond prices, creating a once-in-a-lifetime bull market in bonds and helping fixed-income assets pull their weight in the asset allocation model.

Today, the underlying issue is that with rates so low, the bond side of the equation isn't keeping up with historical norms or even rates of inflation. This is especially so as those inflationary forces move from being just “transitory,” which we’ve discussed ad nauseum over the last year and a half.

And as the Federal Reserve raises interest rates, the bond side of the equation falls in price to match the new, higher yields. Those combined factors have made it a tough go for a classic 60/40 portfolio over the last 15 years and that will almost certainly continue in the years ahead.

This is what has forced us and other advisors to rethink core asset allocation models over the years. At Cornerstone, we’ve adjusted by increasing the weight of equities in general and adjusting the types of fixed-income possibilities away from traditional fixed-income assets and towards alternative assets.

The main idea is that we think equities will provide a better real return given the rates of inflation and the Fed's need to raise rate over the next few years. For example, research from PNC shows that based on 7.5% annual return assumptions, an 80/20 portfolio construction works better over the long term than a 60/40 portfolio while still reducing risk.


When analyzing this, the key consideration is how long bond returns may remain under pressure. Is it a cyclical change (i.e., short-term in nature) or is this a more secular phenomenon that will be longer lasting?

Admittedly, it’s tough to know for sure. What we do know is this: if we're going to assume a traditional 7.5% annual target return, we need to create portfolios that will at least maintain, if not modestly grow, the purchasing power of the principal over time. We know already that a 60/40 asset allocation would have struggled to meet this goal during the last 10 years:

But what asset allocation can meet that return objective over the next 10 years?

Below is a table with the key characteristics of a few sample portfolios looking out over the next 10 years. None of them achieve 7.5%, though the “7.5% Target” portfolio comes close. Notice how that portfolio thinks outside the box by allocating a fairly sizable portion (30%) to alternatives (e.g., real estate, private debt, business development corporations, fixed index annuities, etc.):

To be clear, we're not suggesting that investors load up on alternatives or go all international equities. However, this analysis does underscore the importance of considering a more nuanced approach to portfolio construction, particularly in today's market.

This is why at Cornerstone we generally devote smaller allocations to traditional, vanilla fixed-income assets, instead using alternatives when appropriate or practical to help generate incremental return while still being conscious of portfolio risk.

The key is to not go gangbusters when reconfiguring the overall asset allocation!

In addition to the strategies mentioned above, a focus on dividend stocks also help could do the trick, especially those that can raise payouts. With dividend growth rates historically eclipsing rates of inflation, these sorts of stocks are set to be in high demand as the Fed raises rates. They’re also generally less volatile than non-dividend payers.

We may already be seeing the transition to this type of portfolio allocation from an equity standpoint. Dividend payers are typically classified as value stocks and there has been a significant return reversion both year-to-date and over the past year from growth to value:

To be clear, growth is still an important part of a diversified portfolio. We’re merely referencing the fact that data is starting to show equity rotation to value (i.e., dividend payers), at least in the near-term.

To sum it all up, a 60/40 portfolio simply isn’t diversified enough in today’s market conditions. Several factors make holding too many traditional fixed-income assets a losing proposition. In the end, a more nuanced combination of equities along with a different focus on the types of income-producing assets could be the best medicine going forward from a risk-adjusted return standpoint.

Securities sold through CoreCap Investments, Inc., a registered broker-dealer and member FINRA/SIPC; advisory services offered by CoreCap Advisors, Inc., a registered investment advisor. Cornerstone Financial and CoreCap are separate and unaffiliated entities.