Is the 60/40 Portfolio Feeling ’22?

The threat of higher inflation in 2025 may have balanced fund investors recalling a year they remember all too well. In 2022, accelerating inflation led to higher interest rates that roiled both stocks and bonds and left 60/40 investors with their worst single-year loss since the financial crisis. Now with tariffs that could put additional pressure on consumer prices potentially looming, there’s a higher degree of uncertainty around the path of inflation and interest rates.

Investing always involves unknowns, and after inflation’s recent hit to the 60/40 portfolio, some investors may feel a growing ennui with the classic approach. But before ditching the tried-and-true portfolio to fall in love with strangers like private investments, here are some factors to consider.

Stock and Bond Valuations Are Moving in Different Directions

In the most recent Morningstar Markets Observer, we looked at how the current valuation of US 60/40 portfolios compares with history. Although stock prices still look expensive, bonds offer a much more attractive starting point than they did in 2022. That should help the bond side of the portfolio hold up better during stock market turbulence than it did during that forgettable year.

To measure the valuation of the portfolio, we used two forward-looking metrics dating back to mid-1998, the earliest the data was available. For the stock portfolio, we looked at the forward price/earnings ratio; for the bond portfolio, we looked at the yield-to-worst. We first used this methodology in 2023.

Forward P/E ratios consider in the denominator the consensus best guess for what company earnings will be in the future. It’s a good way to capture the growth expectations that are priced into the market. Like any good crystal ball, however, it offers only hints at the future, never fully revealing what’s to come. Nonetheless, lower forward P/E ratios are generally better starting points than higher forward P/E ratios.

Bond investors are stereotyped as being more pessimistic than stock investors and always focusing on what could go wrong. Yield-to-worst captures that paranoia better than other data points. It calculates the lowest yield an investor can expect if factors that befuddle basic bond math like call provisions and prepayments come into play. The higher the yield-to-worst is, the more attractive that basket of bonds is, and vice versa.

Over the last year, the forward P/E ratios have moved up for the Morningstar US Stock Market Index, but because interest rates have continued to rise, particularly in the fourth quarter of 2024, the yield-to-worst for the bond part of the 60/40 portfolio has been flirting with its highest levels since before the global financial crisis.

Is the 60/40 Portfolio a Good Investment Now?

To find the value of the 60/40 portfolio, we asset-weight each ratio (60% forward P/E and 40% yield-to-worst), and because the two metrics move in opposite directions, subtract the yield-to-worst from the forward P/E ratio. For example, at the end of December, the forward P/E ratio of the Morningstar US Market Index was 21.31, and the yield-to-worst for the Bloomberg US Aggregate Bond Index was 4.91. The year-end calculation—(.06*21.31) – (.4*4.91)—gives us 10.82. That number on its own is useless, but it allows us to compare how the valuations of the 60/40 portfolio have changed over time and how it compares now by measuring how many standard deviations it is away from its long-term average.

This calculation, typically called a z-score, shows the 60/40 portfolio has gotten more expensive in the last year, but it’s still well below its peak at the end of 2021, thanks to the bond portfolio’s more attractive valuations.

This method helps identify when the portfolio is priced below average (a negative z-score) or above average (a positive z-score). Historically, however, the most meaningful signals have occurred when the 60/40 portfolio’s valuation reaches an extreme. For instance, a z-score of 2 or higher means the portfolio is more expensive than 97.5% of observations, while a z-score of -negative 2 or lower signals the opposite.

The only time the 60/40 valuations were stretched above 2 was in 2021 right before one of its worst years of annual performance. The cheapest valuation was during the depths of the global financial crisis in 2008, right before it rebounded for one of its best years. It isn’t a magic formula though. Right before its worst year in 2008, the valuation looked compelling relative to the overall time period we observed (it also shows the limitations of our limited data set at the time).

Begin Again

The bond portfolio’s primary goal in the 60/40 is to provide diversification to stocks while offering better return prospects than cash. As its current yield-to-worst is near its highest in a long time, it’s set up well to deliver on both of those goals. Last week, for example, when DeepSeek’s latest artificial intelligence model sent shockwaves through global stock markets, US core bonds notched a positive return of 0.48% for the week, while US stocks shed 0.89%. We saw similar resilience during last summer.

Although there have been a few years over the past 25 when bonds seemed to have failed their purpose, the 60/40 portfolio generally has a good long-term track record. Especially for long-term investors who appreciate risk mitigation, the 60/40 portfolio looks like an attractive end game.

Joseph Weas, investment analyst, contributed to this article.