Don't write off the always-popular "60/40" portfolio just yet. It's set up for a "strong decade," says ETF and mutual fund giant Vanguard.
The 60/40 portfolio, a commonly followed strategy of holding 60% of your money in stocks like the S&P 500 and 40% in bonds, dropped a "punishing" 16% in 2022. And yet, the strategy is set to work again. Why? Simply stated: The strategy stumbled so badly last year it's set up for much better returns in the near future.
"While 2022 may have been painful for (60/40) investors, the result was that valuations for asset classes are now lower, and most are fairly valued," said Todd Schlanger, senior investment strategist at Vanguard.
Part of that's due to the S&P 500 being down. But it's more about bonds being set up for gains. "(Fixed income) expected returns (are) more than two times higher than they were going into 2022," Schlanger said. "Far from being dead, the 60/40 portfolio is poised for another strong decade."
The Return Of The 60/40 Portfolio
So what kind of return might you expect from this classic balanced portfolio? Vanguard is saying 6.09% annually in the next 10 years is reasonable. Talk about an improvement. That's roughly double the portfolio's anemic 3.83% expected return at the end of 2021.
And if Vanguard is right it would be a solid return to form, critical for a portfolio that's the cornerstone of many investors' long-term plans. The 60/40 portfolio returned 6.1% a year on average in the 10 years through 2022. If that seems low, it's only because the 60/40 portfolio performed freakishly well in the nine years leading into 2022. It generated a "lofty" 8.9% annualized return during that time. "The past decade has been a strong run for the 60/40," says Vanguard's Schlanger.
So better times are ahead. "Vanguard's modeling shows that the return outlook and the worst-case risk scenario for the 60/40 portfolio have notably improved," said Ziqi Tan, a Vanguard investment strategist.
What's Powering A 60/40 Rally
Vanguard dissects the ingredients that go into a 60/40 portfolio to determine its brighter future. Specifically, Vanguard says non-U.S. stocks, U.S. bonds and non-U.S. bonds are all now fairly valued and almost undervalued.
U.S. bonds, for instance, are now trading for just 43% of their fair value, much cheaper than their 55% valuation in 2021. Additionally, non-U.S. bonds are now on the verge of being undervalued. Even U.S. stocks, still stretched in valuation, are only trading for 79% of their fair value, down from their nosebleed 98% valuation in 2021, Vanguard found.
Additionally, Vanguard expects the odds of a 10% drop in the portfolio to have declined dramatically. The odds fell to just 39.5%, down from 59.5% at the end of 2021.
"With current valuations, expected returns for the next decade have improved," says a research note from Vanguard.
Returns Looking Up For 60/40
Vanguard says the popular balanced portfolio's returns will improve dramatically
| Forecast as of year-end … | 2021 | 2022 |
|---|---|---|
| Expected annualized 10-year median return | 3.83% | 6.09% |
| Expected annualized 10-year median volatility | 9.51 | 9.86 |
| Expected maximum drawdown in any given year | -46.73 | -40.97 |
| Probability of 10% loss in any given year | 59.50 | 39.49 |
Source: Vanguard
Follow Matt Krantz on Twitter @mattkrantz
