How Did the 60/40 Portfolio Do in 2021?

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. As we rolled into 2021, some market watchers proclaimed that the 60% stock/40% bond portfolio was dead. Were they right? Joining me today to discuss how the 60/40 portfolio held up in 2021 is Jason Kephart. Jason is a strategist with Morningstar's Multi-Asset Funds Research team.

Hi, Jason. Nice to see you.

Jason Kephart: Thanks for having me, Susan.

Dziubinski: Let's start at the beginning with a little bit of a refresher on what the 60/40 portfolio is and how it became this standard benchmark for balanced asset allocations.

Kephart: Yeah, the 60/40 has become a rule of thumb starting asset allocation. It typically falls into the moderate risk bucket. So, for investors that don't want to take all the risks from the stock market, want something a little bit more balanced, that 60/40 portfolio falls in that sweet spot. Jack Bogle used to like to say he invests half his money in stocks and half his money in bonds. That way, half the time he's mad he doesn't have more stocks and half the time he's mad he has too many stocks. And we know historically the odds are in the favor of stocks outperforming bonds over any given time period. So, I think that's how you go from 50/50 to 60/40. You tilt the odds a little bit in your favor.

Dziubinski: Unpack for us, why there was so much talk earlier in 2020 about how the 60/40 portfolio was dead. What were the factors that were driving those comments?

Kephart: Well, it's funny is that it's not the first time people have proclaimed the 60/40 is dead. After the financial crisis of 2008, when we had the so-called "lost decade" in stocks, you had a lot of people proclaiming the same thing that the 60/40 was dead, you can't trust the stocks in your portfolio, you need alternatives, you need all these other things. And now, this year, coming into this year, we heard the same thing, but now it wasn't the stocks that were the problem, now it's the bonds. Interest rates are low. There's nowhere for them to go but up, and so rising interest rates are going to be bad for your bond portfolio, potentially high inflation could be another headwind. So, that was all the things that people thought would really kill the 60/40. And in 2020, we've actually had the perfect storm of that happen. Rates are higher today than they were a year ago. Inflation is significantly higher than it's been, and yet the 60/40 is alive and well.

Dziubinski: Yeah. So, how did it do? That's what I want to get to. It's not quite dead yet, is it?

Kephart: Yeah. So, through the end of November, the 60/40 has returned about 15%, and I'm using just a generic stock and bond 60/40 portfolio for an example here. So, about 15%. And so, real return after you adjust for inflation, even with high inflation, that's about an 8% real return, which is pretty great. I looked at the rolling 12-month real returns for the 60/40 since 2000. The median over that last 21 years is about 7.5%. So, it's actually outperformed its median real return over that time period. So, even though all this doom and gloom came true, it didn't derail the 60/40.

Dziubinski: And why not? Like what did the naysayers get wrong about this?

Kephart: I think the naysayers got wrong just having this myopic focus on the fixed-income portfolio. In the 60/40, the fixed income is not really there to be a return driver. It's there to balance out the risk from your equity portfolio. And the bonds did have a bad year. Like, the Barclays Agg is down about 1%, 1.5% year-to-date, but stocks are up 22%, the U.S. stock market. So, that's really what carries a 60/40. Whether or not the 60/40 is going to deliver depends far more on how the stock part of it does than the bond part of it. And even though we have seen interest rates rise, stocks have still done very well year-to-date.

Dziubinski: Speaking of expectations, what do you think investors should be expecting for the 60/40 portfolio going forward, given where interest rates are and where the stock market valuations are today?

Kephart: Yeah, there might be some short-term volatility. If we get another taper-tantrum-like situation where rates rise fast enough that they cause the stock market to tumble, and typically what you'd see is that is going to really affect the high P/E stocks, the growth stocks. So, if you have a balanced portfolio between growth and value or something like the S&P 500, that's not going to be as big of a problem, I think, for you. But I think generally, given where stock valuations are and interest rates are, you probably would want to set your expectations a little lower going forward. One thing you do to, I think, maybe improve your chances of success is look at a more internationally diversified 60/40. So, Vanguard Balanced Index is kind of your classic U.S-only. Vanguard LifeStrategy Moderate Growth is a very similar fund, 60/40 equity and bond split, but it holds a bunch of international equities in addition to it. So, we've had this decade where U.S. stocks have just really crushed the rest of the world. So, one thing I think you could do to improve your odds are think a little bit more diversified than just U.S. stocks and bonds.

Dziubinski: Now, lastly, Jason, you mentioned earlier in our conversation that this 60/40 is a benchmark and that it is an allocation for some people who maybe don't want to go all-in on the stock market. But from a practical standpoint, people always hear that they should use their time horizon, their goals, and the size of their portfolio to really determine what their asset mix should be. So, for most people, is the 60/40 portfolio most useful as just a commentary on the value of diversification? How do you think investors should think about it?

Kephart: I think it's definitely not something for a short-term investment. With 60% stocks, you're going to have volatility. You could have drawdowns. In 2008, 2020 drawdowns were a little north of 20%. So, that's your downside risk. So, if you're investing for something six, 12, even 18 months from now, a 60/40 is probably a little too volatile for that. But I think if you have a long time horizon, it's a very good starting point, and it's proven very difficult to beat because the stocks and bonds, when it's like an investment-grade bond portfolio, really balance each other out nicely. And unless that correlation between those two really significantly changes, which it's hard to see how it would, though it could over shorter periods, I think it's a really good long-term investment, and it's definitely been a very hard benchmark to beat.

Dziubinski: Jason, we're going to be revisiting this with you in 2022 because we know you'll be watching it. We appreciate your time.

Kephart: Thank you so much for having me.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.