The Return of the Classic 60/40 Portfolio

In a surprising turn of events, the classic 60/40 portfolio has made a comeback and looks set to stay for the long-term. Vanguard, the second-largest asset manager in the world, has recently released its 2024 outlook and declared that the case for the 60/40 investment strategy has strengthened.

The 60/40 portfolio consists of a mix of 60% stocks and 40% bonds. According to Vanguard, while stock returns are predicted to be lower over the next decade, bond returns are expected to be higher due to prevailing lofty interest rates. In fact, Vanguard considers this new era of higher interest rates as the "single best economic and financial development" in the last 20 years.

Roger Aliaga-Diaz, Vanguard's global head of portfolio construction, stated in an interview that they believe the 60/40 portfolio has the potential to deliver returns of approximately 6% to 7% over the next 10 years, which aligns with historical averages.

Vanguard goes on to assert that the probability of achieving a 10-year annualized return of at least 7%—the post-1990 average—for long-term investors in balanced portfolios has increased from 8% in 2021 to an impressive 40% today.

To reflect their confidence in bonds, Vanguard has made a "strong tilt" towards bonds in its time-varying portfolio. This type of asset allocation allows for adjustments over a 5-10 year timeframe. In this portfolio, the traditional 60/40 mix is inverted to 59% bonds and 41% stocks. Vanguard refers to this as a "meaningful de-risking move" as it offers a similar expected return to the traditional 60/40 benchmark but with lower volatility—making it an attractive option for the average investor.

Regarding the bond portion of the 41/59 allocation, Aliaga-Diaz explains that it includes an overweight to intermediate credit bonds. While this entails taking on slightly more risk on the fixed income side, it also comes with the benefit of higher yield compared to the regular Bloomberg U.S. Aggregate Bond Index. Over a 10-year period, this higher yield is expected to contribute additional returns.

In conclusion, the classic 60/40 portfolio has reemerged and is poised to deliver consistent returns in the next decade. With lower stock returns predicted and higher bond returns anticipated, Vanguard believes that now is the time to embrace this well-balanced investment strategy.

Vanguard Introduces New Strategies for Passive Investors

Vanguard, the renowned investment management company, continues to recommend the tried-and-true 60/40 portfolio as their strategic choice for passive investors. However, they believe that those investors who are willing to embrace model forecast risk may find a 40/60 portfolio more advantageous. This approach allows investors to express their intention to take on a slightly higher level of risk.

In a move to align with this updated perspective, Vanguard is now proposing similar strategies in the model portfolios used by financial advisors. This ensures that their recommendations are consistent across the board.

Vanguard has also revised their U.S. bond return expectations for the next decade. They anticipate a nominal annualized return of 4.8%-5.8%, a significant increase compared to the previous forecast of 1.5%-2.5% prior to the Fed's rate-hiking cycle. Similarly, for international bonds, Vanguard now expects annualized returns of 4.7%-5.7% over the next ten years, compared to the previous projection of 1.3%-2.3% during low or negative policy rates.

Vanguard assures investors that if they reinvest the income component of bond returns at these elevated rates, it will eventually surpass the capital losses experienced in recent years. This serves as an encouragement for those who may have been discouraged by the previous performance of bonds.

However, it is important to consider the potential impact of a higher interest-rate environment on asset price valuations worldwide. As rates increase, global markets may experience a decline in asset prices while profit margins for companies issuing and refinancing debt may be squeezed. Vanguard acknowledges that valuations in the U.S. are currently stretched and, as a result, has adjusted its U.S. stock return expectations to an annualized range of 4.2%-6.2% over the next ten years.

The year 2022 was challenging for both stocks and bonds, with the S&P 500 falling by 18% and U.S. Treasuries and global high-yield debt experiencing a decline of 13%. Some strategists have even suggested abandoning the traditional 60/40 approach in favor of alternative asset classes for potentially higher returns, despite sacrificing some liquidity.

Amidst this backdrop, Vanguard has remained steadfast in their support of the 60/40 way of investing and the associated portfolio. According to Aliaga-Diaz, they have been vocal advocates for this strategy throughout the period of 2022-2023.