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Your Investing Strategy Just Failed. It's Time to Double Down. -- WSJ

The Wall Street Journal · 01/06/2023 11:00

By Jason Zweig

Many investors have been despairing that the 60/40 portfolio, that venerable mix of 60% stocks and 40% bonds, is dead.

Instead, they should be celebrating its resurrection. A so-called balanced portfolio is better-positioned to provide decent returns at moderate risk than it's been in at least 15 years.

That may sound like cold comfort if you just got creamed, and if you're deep in retirement you might not have time to recover. But early retirees and younger investors should regard the recent calamity as an opportunity.

In 2022, 60/40 portfolios had one of their worst years in history -- because bonds had their worst year ever.

Historically, the minority position in bonds provided the ballast for a 60/40 portfolio if the majority stake in stocks took a hit.

Last year, though, bonds lost 13%, with long-term Treasurys slumping more than 29% -- far worse than the 18% fall in the S&P 500.

Instead of being ballast for a balanced portfolio, bonds turned into a torpedo. A typical 60/40 portfolio lost about 15% last year; if its bonds were long-term, the losses were even steeper.

The culprit, of course, was the rise in interest rates orchestrated by the Federal Reserve.

Last year's bad news, though, foretells better times ahead for fixed-income investing. Rates have risen so far so fast that bonds finally offer decent yields of around 4% after paying diddly-squat for what felt like an eternity. Inflation-protected Treasurys even offer yields of roughly 1.6% above inflation.

The Fed says it isn't done raising rates, so more pain is possible. The worst is probably over, though, and history puts today's opportunities in perspective.

Using long-term bonds (which were often the only available option in the past), last year's returns for a 60/40 portfolio were the fourth worst in any 12-month period since 1792, according to Edward McQuarrie, an emeritus professor of business at Santa Clara University who studies asset returns over the centuries.

Based on normal risk-return relationships since the advent of modern bond-market data in the 1970s, the typical 60/40 portfolio's extreme losses last year had a probability of occurring only once in every 130 years, according to T. Rowe Price Group Inc.

Risk-return relationships aren't always normal, though -- and that's exactly the point.

Stocks normally go up -- but not always. Bonds normally are safer -- but not always. Nothing in financial markets is constant or permanent.

We could already be in a radical new era of rising interest rates and raging inflation. The more sensible assumption, though, is that a once-in-a-blue-moon bad year for bonds doesn't invalidate decades of data showing that, on average, they can effectively diversify the risks of stocks.

Bond prices have fallen and yields have more or less doubled in the past 12 months, meaning that the future returns on fixed-income assets are much more likely to bolster a 60/40 portfolio.

"We've already had 2022," says Sébastien Page, head of global multi-asset management at T. Rowe Price. "We've had the interest-rate shock! That's in the price."

One clear caveat: A balanced portfolio of stocks and bonds is "fraught with the opportunity to underperform" again if inflation remains high, says Matthew Wright, former chief investment officer of the Vanderbilt University endowment and now president of Disciplina Capital Management LLC, an investment firm in Nashville, Tenn.

Mr. Wright suggests thinking of it instead as a 60/30/10 portfolio consisting 60% of growth opportunities like stocks, 30% of such diversifiers as fixed income and 10% of assets that protect against inflation.

Mr. Page recommends tilting at least 5% of your stock position toward "real equities," shares in industries such as energy, real estate and natural resources that could benefit from persistent inflation.

If you invest primarily in a taxable account, you might consider using some individual stocks, since you can reap tax benefits from any losses there. You should favor tax-free municipal bonds for at least part of the 40% in fixed income.

In a tax-advantaged retirement account, you could tilt your 60% stock allocation toward cheaper "value" funds. And making Treasury inflation-protected securities a big chunk of your fixed income, especially if you plan to hold for the long term, is an excellent step.

Naturally, a 60/40 portfolio isn't right for everyone. It's simply one of many possible ratios of stocks to bonds: 70/30, 80/20 or anything else on the continuum from 100% stocks all the way down to 100% bonds.

Like most such ratios of asset allocation, it also gives you a target for rebalancing. When either stocks or bonds go way up or way down, you should buy enough of whatever's fallen behind to get you back to your preset level of exposure to that asset.

The investment theorist Peter Bernstein, who died in 2009, liked to call 60/40 "the center of gravity" for long-term investors. That's because, over long periods, its 60% stake in stocks has tended to produce returns not much lower than a 100% position, while the 40% in bonds has usually blunted the sharp declines that stocks deliver along the way.

Historically, that combination of decent returns and a smoother ride has enabled 60/40 investors to stick with their plan, whereas many who started out with more-aggressive allocations to stocks haven't been able to stomach the market's deepest downturns.

In short, a 60/40 portfolio makes the most sense for people who want to take a moderate amount of risk with a minimal amount of worry.

That didn't work in 2022. It might not even work in 2023. Over the longer term, though, it should work just fine.

Write to Jason Zweig at intelligentinvestor@wsj.com

(END) Dow Jones Newswires

January 06, 2023 11:00 ET (16:00 GMT)

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