Can the 60/40 Portfolio Win in 2024?

Key Takeaways

• The 60/40 portfolio is the standard-bearer for investors with a moderate risk tolerance. It gives you about half the volatility of the stock market but tends to provide good returns over the long term. For the past 20 years, it’s been a great portfolio for investors to stick with.
• Since 2022, stock and bond performance have been coupled together. A lot of the reason we saw the pain in stocks in 2022 was because interest rates were rising so quickly. And in 2023, we’ve seen interest rates stabilize.
• The bond portfolio looks so much more attractive today than it did heading into 2022. So, it’s unlikely you’re going to see double-digit losses like you saw out of that part of the portfolio. That also means you’re going to see a return to diversification.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. The 60% stock/40% bond portfolio endured a painful 2022. How did it do in 2023? And what are its prospects in 2024? Joining me today to unpack the performance of the 60/40 portfolio last year and to discuss what investors might expect going forward is Jason Kephart. Jason is Morningstar’s director of multi-asset ratings.

Nice to see you, Jason.

Jason Kephart: Thanks for having me, Susan.

Why Do People Like the 60/40 Portfolio?

Dziubinski: Let’s kick things off with a reminder for viewers about what the 60/40 portfolio is and why people like us in the industry talk about it.

Kephart: Sure. It’s kind of your standard-bearer portfolio for someone with a moderate risk tolerance. 60% stocks/40% bonds gives you about half the volatility you’re going to get from the stock market but tends to give you really good returns over the long term. Over the last 20 years, it’s been a great portfolio for investors to stick with.

The 60/40 Portfolio Performance

Dziubinski: The 60/40 portfolio, it’s been good except it was horrible in 2022 with both stocks and bonds, of course, enduring sizable losses that calendar year. So, let’s fast forward to 2023. Things couldn’t have gotten much worse. How did they look?

Kephart: They didn’t get worse. They actually got better. The 60/40 portfolios gained about a little over 10% through the end of November, which is a pretty good return, still below its high-water mark that it hit at the end of 2021. But given what’s going on with interest rates, the future is looking a lot better for it.

Dziubinski: What’s really responsible? What’s driven that rebound? Has it been a strong stock market in 2023? Has it been bond market performance? Some combination of the two?

Kephart: Since 2022, they’ve really been coupled together, stock and bond performance. A lot of the reason we saw the pain in stocks in 2022 was because interest rates were rising so quickly. And in 2023, what we’ve seen is interest rates are really stabilized. The Fed has paused its hiking for now. Inflation seems to be coming down. That’s created more stability in the stock market. Stocks have done well, and bonds have also done well. So, you’re getting that classic mix of both stock and bond returns being positive that we really experienced over most of the last 20 years except for 2022.

Dziubinski: Jason, your team has developed a new metric that gauges the attractiveness of the 60/40 portfolio as an investment. Tell us about this metric.

Kephart: Yes. What we did was take two classic measures of valuation for stocks and bonds and put them together. For the stock portfolio, that means we looked at forward price to earnings of broad U.S. stocks. And then we also looked at the yield to worst for core U.S. bonds. All else equal, you’d rather buy stocks when the forward price to earnings is lower than it has been in the past rather than higher. And with bonds, you’d rather buy them when their yield to worst is higher than they’ve been in the past. And what we’ve seen is, given how it’s compared, like what the portfolio looks like today versus what it’s looked like in the past, it’s trading just a little bit above average, but nothing that would make you think that it’s really overvalued.

One thing I found interesting when we looked at this going back to 1995 is the end of 2020 was actually the most expensive the portfolio has been to itself relative to history, even surpassing what we saw in the tech bubble. And what we see is that those extreme valuation levels, things tend to mean-revert, but it tends to work best when things are really at extremes. So, now with it just being a little bit over its long-term average, it seems like there’s not as big a risk of a big mean reversion like you had in 2022.

What to Expect from the 60/40 Portfolio in 2024

Dziubinski: As we’re heading into 2024, what might investors expect given where we are in 2023?

Kephart: Well, I think given where the bond portfolio is today with the U.S. Aggregate Bond Index yielding somewhere between 4.5% and 5.0% given the day, the bond portfolio looks so much more attractive today than it did heading into 2022. It’s just so unlikely you’re going to see double-digit-type losses like you saw out of that part of the portfolio. And I think that also means you’re going to see a return to diversification.

One thing that failed in 2022 is that the stock and bond correlation that had been the biggest feature of a 60/40 portfolio fell apart, with them both losing money at the same time. But now given where rates are, bonds should be a lot more resilient. And if there is some kind of economic event that causes stocks to sell off significantly, I think you’re going to see that bond portfolio be a lot more resistant to those drawdowns than it was in 2022.

Dziubinski: Let’s talk a little bit about bonds. Given that we are in a higher interest-rate environment than we’ve been in a while, should investors be thinking about tweaking or doing anything to that bond sleeve, that bond portion of their 60/40 portfolio?

Kephart: Typically, in a 60/40 portfolio, that 40% we’re talking about is like U.S. core bonds, investment grade, Treasuries and corporate bonds, and mortgage-backed securities. Things that are relatively safe. You can stretch out and get higher yield from things like high-yield corporate bonds, emerging-markets debt. But I think what you always have to keep in mind is these higher-interest-rate securities tend to be more sensitive to economic changes like stocks. So, you’re really diluting some of that diversification benefit you’re getting from the bond portfolio. And given where rates are right now and the yields you’re getting on just safe bonds, it doesn’t seem like there’s a great benefit to reaching out for extra risk. And if you really feel like you need extra risk, maybe a moderate portfolio is not right for you.

Dziubinski: The 60/40 is not the place to be perhaps then, right? Let’s talk a little bit, just in general wrapping up, what are the advantages, the pros and the cons to investing in a 60/40 today?

Kephart: The pros are basically you should be getting good diversification from the stock and bond portfolios. We do expect bonds to have a positive return going forward. The best predictor of what bond returns are going to be is their current yield. And we’re between 4.5%, 5.0%. That should be a fairly good proxy for where you should expect from that bond portfolio over the next, call it, five to seven years. Stocks are going to be susceptible to things that happen economically. If we do go into recession, that would be very painful to a 60/40 portfolio. But relative to owning something that’s 80% stocks or 100% stocks, your drawdown is going to be a lot less. And the bonds really should be a lot better of a diversifier like we had seen prior to 2022 going forward.

Dziubinski: It sounds like, again, interest rates being where they are is a real benefit for the 60/40 portfolio.

Kephart: And especially now that rate hikes seem to have at least slowed down. Now you’re actually reaping the benefits of those higher rates in the form of higher returns. Whereas before when interest rates just kept rising, it’s kind of like a lot of little painful little cuts. But through the end of November, the bond market had a positive return for the first time since 2020. So, I think we’re starting to see that kind of sea change.

Dziubinski: Well, thanks for your time, Jason. We’ll see you the same time next year to talk about how the 60/40 portfolio did in 2024.

Kephart: Thanks for having me.

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

Watch “Can the 60/40 Portfolio Bounce Back in 2023?” for more from Jason Kephart.