Two years ago Vanguard published a note for its clients titled “Like the phoenix, the 60/40 portfolio will rise again." And it did. The mutual-fund giant’s take on the classic, “safe" mix of 60% stocks and 40% bonds, which peaked in 2021, clawed back its losses by this February. But the fact that Vanguard felt the need to talk some customers off the ledge shows how poorly understood the approach is.
Even worse, investors might be worried about the wrong retirement rule of thumb. Most commonly understood as a 60% allocation to the S&P 500 stock index and 40% to intermediate bonds like 10-year Treasury notes, the ratio and exact holdings aren’t set in stone. It is just shorthand for a mix that gets you the best return for the least choppiness, according to modern portfolio theory.
But 2022’s swoon was a reminder that money can still be lost: It was a 60/40 portfolio’s worst year after inflation since 1974, a year before Vanguard was founded. With the Federal Reserve regularly riding to the rescue over the past quarter century, investors had been conditioned to expect bonds to act like a shock absorber, buffering a bad year for stocks. That is actually pretty rare, though, according to a 200-year retrospective by Morgan Stanley Investment Management.
Ironically, the lower bond yields are when a stock swoon begins, the less potential bond prices have to rise in a sharp economic downturn. If a recession caused yields on 10-year Treasury notes to drop to 1.5% today then their price would rise by about a fifth. Back in 1974, a plunge to the same yield would have spurred a rise of around 50%.
Read more on livemint.com