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Can the 60/40 Portfolio Bounce Back in 2023?

Performance probably can’t get much worse than it was in 2022.

Key Takeaways

  • Jack Bogle used to say that he had 50% of his money in stocks and 50% of his money in bonds. We use the 60/40 portfolio because stocks tend to outperform bonds over time, so that extra 10% in stocks tilts the odds in your favor.
  • The 60/40 portfolio was down about 20% in 2022, but it clawed back a lot of that through the end of the year. The trouble for bonds and stocks was runaway inflation.
  • The 60/40 portfolio is a starting point, and then you have to think about your risk tolerance. If 60% in stocks is too risky for you, then you probably want to move more conservatively. Your time horizon and risk tolerance should be really big factors.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. The 60% stock/40% bond portfolio suffered a horrible fate in 2022. 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.

Hi, Jason. Good to see you today.

Jason Kephart: Hi, thanks for having me.

Dziubinski: So, let’s start out with a little bit of a refresher on what the 60/40 portfolio is and how it became the standard benchmark for balanced asset allocation.

Kephart: Sure. It always reminds me of an old Jack Bogle quote. Jack Bogle used to say that he had 50% of his money in stocks and 50% of his money in bonds. That way, half the time he was mad he didn’t have enough risk and half the time he was mad he had too much risk. So, I think that 50/50 balance is kind of where it started. Now why 60/40? Because stocks tend to outperform bonds over time, so that extra 10% in stocks really tilts the odds in your favor a little bit.

Dziubinski: Let’s get to the numbers, Jason, which are a little bit ugly. How did the 60/40 portfolio perform in 2022?

Kephart: It was a rough year. At its worst, it was down about 20%, but it’s clawed back a lot of that through the end of the year. So, by the end of the year, it was only down about double digits. Still, a pretty painful year though for moderately risk-averse investors.

Dziubinski: Investors often think of bonds, which is that 40% part of the portfolio, of course, as a buffer for stocks. But the bond market really took a hit in 2022 as the Fed aggressively was raising interest rates. So, let’s talk a little bit about what impact the performance of that bond sleeve in particular had on the 60/40 portfolio last year.

Kephart: The trouble for bonds and stocks this year was really this runaway inflation. That’s what caused the Fed to so aggressively hike rates. And obviously, when rates are rising, that’s bad for bonds. Rates go up, bond prices go down. So, that’s been painful. And also, it caused stocks to sell off. And usually, what we’ve seen, especially over the last decade, is that when stocks have fallen, high-quality bonds like U.S. Treasuries have generally been a really safe haven and done a really good job of offsetting some of that risk. But this year, you really didn’t have that safety net from bonds. So, they were both falling and that really doubled the pain for investors.

Dziubinski: And you referred to that behavior between stocks and bonds normally, which we refer to as correlations, and they’ve really flipped into positive territory now. So, what might that mean for the 60/40 portfolio going forward?

Kephart: Positive correlation isn’t necessarily a bad thing for stocks and bonds if they’re both going up at the same time. When you really want the negative correlations is when stocks are falling. But stocks predominantly are the risk in your portfolio. In a 60/40 portfolio, about 90% of your volatility over normal periods is going to be driven by the stock portfolio. So, you really want your bonds to be that ballast, and that’s really what we haven’t seen this year. But now that yields are a lot higher, I think bonds have become a lot more attractive, and that means when stocks do sell off, I think you’ll really see people flee back into bonds like they have in the past. So, I do expect that going forward that stock/bond correlation that pairs really nicely together, I think we’re going to see that come back.

Dziubinski: Let’s gaze into that crystal ball, Jason. What do you think investors can fairly expect from a 60/40 portfolio given where we are with bond yields today and where stock market valuations are?

Kephart: Well, stocks are a lot cheaper than they were at the start of the year, which is usually a good place to invest. Bonds’ yields are a lot more attractive, and that’s a really important thing, I think. Because the higher the bond yields are, the less interest-rate sensitive they are. So, it’s very unlikely that bonds will have another year like they had in 2022. Rates would have to rise very significantly. I think, given how aggressively the Fed has already hiked, that doesn’t seem likely. So, I think the bond portfolio is going to be a lot more stable. There might be some more pain as the Fed continues to hike in the beginning of the year. But they’re probably going to level off at some point. And so, your bond fund should be pretty stable for a while.

Dziubinski: So, Jason, that 60/40 portfolio is really a benchmark and an allocation for investors who may not want to go all in on the stock market due to risk. But then, from a practical standpoint, people always hear they should really determine their asset allocation based on their goals, their time horizon, their risk tolerance, the size of their portfolio, all these other factors. So, for most people, is the 60/40 portfolio just a commentary on the value of diversification? Is it a benchmark? How should investors really be thinking about the 60/40 portfolio?

Kephart: I think it’s almost a starting point, and then you do have to think about your risk tolerance. And if 60% in stocks is too risky for you, then you probably want to move more conservatively. But at the end of the day, your time horizon and risk tolerance should be really big factors. And so, if you have a medium-term time horizon, maybe even longer-term, a 60/40 is a pretty solid balance between stocks and bonds that would give you a pretty solid return profile that’s not as risky as the stock market. And we really don’t think bonds are going to have another year like they had this year. So, I do think if you have a medium-term time horizon, five to 10 years, 60/40 is a really good starting point. But you should definitely think about your risk tolerance. In a year like this year, you can’t stomach, or a year like 2008 when the 60/40 was down 25%, that’s when you really need to think about maybe this is too much risk for you.

Dziubinski: Well, Jason, thanks for your time today, and we’ll see you same place, probably same time next year to talk about a little bit on how the portfolio did in 2023. We appreciate your time.

Kephart: Thanks. Hopefully, it will be a lot happier conversation.

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

Watch “3 Cheap Value Stocks for 2023“ for more from Susan Dziubinski.