The traditional 60/40 portfolio has been a staple investment strategy for decades. It’s simple enough: 60% stocks and 40% bonds, with stocks traditionally giving you the chance for higher upside and bonds traditionally offering steadier returns without much correlation to stocks. Rebalancing between the two regularly can lead to positive and less volatile investment returns.
The issue in the current market is that with interest rates at or near zero, bond returns are less appealing than they once were. The actual yields that investors receive from bonds are minimal and pale in comparison to the yield earned only 10 years ago. Bond prices go up as interest rates go down, but we’re already near zero, so bond prices themselves have less room to go much higher (unless, of course, yields go negative as we have seen with government bonds in parts of Europe and Japan). We’re also potentially entering into an inflationary environment. For bond investors, inflation means that the dollar returns they receive from a given bond will be worth less over time due to the erosion of their purchasing power. And just as bond prices go up as interest rates go down, bond prices also go down as interest rates go up. There’s no more popular cure to inflation than raising interest rates, potentially putting bondholders in a tough spot.
Portfolio diversification across asset classes is still important. Diversification helps lower portfolio volatility and allows investors a better chance to weather all types of markets without seeing the significant market drawdowns that a concentrated portfolio might experience. So, investors can consider taking the same 60/40 principle but applying it to include new asset classes. We’ll call it the new 60/40.
We can start by leaving the stocks portion alone. While the types of stocks that do well in the next 5-10 years may vary from the pandemic winners or the 2010s’ bull market winners, the leading indices are still pretty solid representations of the U.S. and global economy. They are a useful anchor to a portfolio.
The rest of the portfolio is where things get interesting. This is where alternative asset classes come in. They can achieve many of the diversification goals that bonds offered in the traditional 60/40 – uncorrelated returns, potentially lower volatility – but in many cases, may have the potential to offer higher returns.
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It’s worth noting that alternatives do carry their own set of risks, and the specific allocation may not be the right one for your investment needs – investors should assess their own time horizon, risk appetite, liquidity, and financial needs and goals. Wealth professionals suggest allocating 15-20% of one’s portfolios to alternatives.
Here are a few common alternative asset classes to consider:
The idea of the traditional 60/40 portfolio is to have uncorrelated, less volatile investment returns to grow and preserve capital in any environment. In this day and age, with low interest rates and potential inflation, investors should consider investments beyond bonds to help achieve their goals. With alternatives, you may be able to find the right combination for your new 60/40 portfolio.
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