Vanguard says 60-40 investing strategy is not dead and will work out again for investors

Published Wed, Nov 16 20222:12 PM ESTUpdated Wed, Nov 16 20224:44 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

After ugly losses in both stocks and bonds, many investors have written off the 60/40 investing strategy. But Vanguard says the market correction could help this tactic perform much like it has in the past. The strategy is based on a portfolio with 60% of its assets in stocks and 40% in bonds . It has been a classic go-to for many investors, who expect it to provide growth and relative safety while generating steady returns. The 60/40 strategy is on track for its second worst year ever, down about 14.5% in 2022 as of Oct. 31, Vanguard found. "Many investors or clients fear that what they have seen this year is the new normal. They fear that 60/40 doesn't work anymore," said Roger Aliaga-Diaz, Vanguard chief economist, Americas and global head of portfolio construction. The only worse year was 2008, when the strategy lost more than 20%. Aliaga-Diaz said investors should not give up on the investment strategy . He expects after double digit losses this year, the strategy could produce 10-year annualized returns of 6.4% and get closer to a more normal level of 7% annualized returns further out in the future. From 1926 to 2021, the 60/40 portfolio generated annualized returns of 8.8%. "We would say on a forward-looking basis the 60/40 looks more normal than not," Aliaga-Diaz said. Brighter prospects ahead The beauty of the 60/40 strategy is that the two asset classes work as a hedge against the other. When stocks fall, investors often look to safety in bonds. In risk-on periods, investors favor stocks over bonds. "Our point is, with this forward-looking projection, that the 60/40 can produce returns that are very similar, in line with where they have been in the past," he said. "It's been very painful...but on a forward basis we see much brighter prospects." Aliaga-Diaz said the strategy looks set to perform better because stocks are no longer as overvalued as they had been. The 60/40 portfolio also could benefit from the math of average returns which would suggest declines are followed by higher-than-average returns. "Back in December 2021, equities were about 40% overvalued in our view. The ironic thing about this market collapse is, as painful as it has been, the forward-looking prospects are better," he said. "Equity valuations are much more normal, though not normal yet. Some people say they are still 5% to 10% overvalued. But interest rates are much higher, too. The fixed income side of the portfolio should generate more income." Vanguard has funds based on the 60/40 strategy. One is the Vanguard LifeStrategy Moderate Growth Fund , which was down 18.4% for the year as of Oct. 31, its worst since 2008. That fund is recommended for a horizon of more than five years. Another is Vanguard Balanced Index Fund Admiral Shares . As of Oct. 31, it was down 17.39%. This marks the fund's second worst year after the 22.12% decline in 2008. This period has been extreme. "The bond losses have been so significant," he said. "For 60/40, you have losses that are almost on par between bonds and equities. Equities were close to 18% down and bonds are slightly less than that... It's almost like they've been reset... Now yields are at a much higher level, and valuations for stocks are at a much lower level, so prospects are better." According to Vanguard, stocks and bonds have declined together for brief periods. When viewed on a monthly basis, the nominal total returns of stocks and investment grade bonds have been negative nearly 15% of the time since 1976. That would be the equivalent of a simultaneous decline in both asset classes every seven months on average. In an extended time period, the markets declined together less often. Over the last 46 years, there was never a three-year span of losses in both asset classes, according to Vanguard. Drawdowns in 60/40 portfolios have been more frequent than simultaneous declines in stocks and bonds, due to the higher volatility of stocks and their greater weight, Vanguard found. One-month total returns were negative a third of the time over the past 46 years. One-year returns were negative about 14% of the time, or once about every seven years, on average.