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Three Reasons Why the 60/40 Allocation can be a Good Starting Point

03/13/2024 Written by: Kristine Simmons

Many people have the misconception that the primary goal of investing is to make as much money as you can as fast as you can. Unfortunately, you can't just order up outsized returns like a delivery pizza. You have to pay for your chance at them with concentrated risk. The bigger the potential payout, the greater the chance that you won't get it.

On the other hand are the people who want to shield their hard-earned savings from any kind of price fluctuation risk at all. Unfortunately, the places where your money is guaranteed to be safe, such as savings accounts and certificates of deposit (CDs), come with their own kind of risk—the risk of shrinking value caused by returns that don't keep up with inflation.

The financially educated investor, however, understands that the goal of long-term investing is to achieve returns that have a reasonable expectation to beat inflation and multiply by compounding, while at the same time working to minimize the risk of substantial loss. Implementing this type of strategy must be done with discipline and patience.

For more than 50 years, the rule of thumb for pursuing this idea has been a portfolio consisting of 60% stocks (shares of companies) and 40% bonds (debt), or the 60/40 portfolio, for short. This allocation is not a magic formula for beating inflation every quarter or shielding you from all loss. For example, in 2022 when inflation was at 8%1, the S&P 500 index lost more than 18%2, and a hypothetical 60/40 portfolio would have lost about 16%3. But over the long-term, this allocation has been able to consistently deliver "normal" returns.

According to Roger Aliaga-Diaz, chief economist and head of portfolio construction at Vanguard, there are three reasons why 60/40 is still a good rule of thumb.

First, it seeks to benefit from the generally divergent behavior of stocks and bonds. Over the long-term, when stocks go down, bonds tend to go up and vice versa.

Second, academics and industry analysts have gained a clearer understanding of the systematic stock and bond risk premiums. And as a result, having a balanced portfolio makes more sense than ever.

Third, the 60/40 held for the long-term tends to be cost-efficient. Though technology is now making additional customization also cost-effective.

The 60/40 allocation makes a good starting point for investors saving for retirement. There is a lot that can be customized within this hypothetical strategy to better fit an investor's risk tolerance, timeline, and retirement goals. We are happy to explain the rationale behind the allocation chosen for your unique situation.

1. http://go.pardot.com/e/91522/ation-current-inflation-rates-/93yd8k/2100551575/h/hTNBS8f5X4H0Jdb9HS-QbnK23KdDtbZnWlpl6pT6JkM

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