Is the 60/40 Balanced Portfolio Broken? Not Forever.

Executive summary:

  • The promise of diversification failed in 2022 as both equities and fixed income declined
  • Some investors are questioning whether the traditional 60% equity/ 40% fixed income balanced portfolio remains a valid strategy
  • Over history, balanced portfolios have rebounded quickly from declines

Everyone knows it by now: 2022 was not a kind year for investors, particularly balanced fund investors. There were no silver linings, no shelter from the storm; it seemed that no matter what levers you had in place to protect clients’ wealth, there was very little to cheer about on investor return statements.

Clients are probably asking themselves (and you): how did this happen? While we can point to a number of likely causes (stubbornly high inflation, central bank tightening, increasing recession risk), I think we can sum it up by admitting that in 2022, the promise of diversification…failed.

When I think of diversification, I think of the classic mix of 60% equities and 40% fixed income commonly known as 60/40 that we’ve all know and trusted for more than seven decades.

When Nobel Laureate Harry Markowitz introduced the 60/40 investment portfolio in his dissertation on Modern Portfolio Theory in 1952, it fundamentally altered the way that both individuals and institutions would invest. Markowitz demonstrated what many before him had not uncovered: that the performance of an individual security mattered less in an overall, well-diversified portfolio. It meant that investors could reduce their portfolio’s risk by investing in a mix of securities that differed in asset classes, capitalization, industries, geographies and return profiles. For years, his theory was proven right. A 60/40 portfolio generally provided a smoother ride for investors than pure equities.

Fixed income has historically been considered the ballast in a portfolio, offering stability and diversification against equity market fluctuations. Over the last 43 years, a balanced portfolio of 60% U.S. equities and 40% U.S. bonds would have returned 9.6% annualized with standard deviation of 11.3%. While a portfolio consisting solely of fixed income would have had lower return with lower risk, a portfolio consisting solely of equities would have had only slightly higher return but substantially higher risk.

Source: Morningstar Direct. U.S. equities=S&P 500 Index, U.S. bonds= Bloomberg U.S. Aggregate Bond Index. Balanced Portfolio=60% S&P 500 Index, 40% Bloomberg U.S. Aggregate Bond Index. Indexes are unmanaged and cannot be invested in directly. Past performance is not indicative of future results. Volatility is measured by standard deviation. Standard Deviation is a statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. The greater the degree of dispersion, the greater the risk