60/40 stock-bond weight rule needs to go on a diet

Advisors


The classic 60/40 rule — an investor should put 60 percent of their portfolio in stocks and 40 percent in bonds — is popular for a reason: It has a good historical track record of delivering equity-like returns, while lessening the risk of serious annual portfolio drawdowns.

Here are a few basic statistics that prove that point.

Since 1928 — the first year data were available — a 60/40 portfolio of the S&P 500 and 10-Year Treasurys has delivered an average annual total return of 9 percent, or 78 percent of the total return for just the S&P 500 (11.5 percent). After inflation (using annual CPI) this translates to a 5.9 percent average total return for 60/40, or 70 percent of the average real returns for the S&P 500 (8.4 percent).

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The 60/40 portfolio saw 19 years with negative total returns during the period from 1928 to 2017 (21 percent of the time). The worst drawdowns for the 60/40 portfolio since World War II: 1974 (-14.7 percent) and 2008 (-13.9 percent). The returns on just the S&P 500 in those years were more than twice the losses of the 60/40 portfolio: -25.9 percent and -36.6 percent, respectively.

The key to the benefits of the 60/40 rule is negative correlation between stocks and bonds. Stock and bond returns show no historical return correlations (0.03) over the 1928–2017 time frame. A correlation of 1.0 implies perfect correlation.

The wrinkle: Stock and bond correlations are not static across time. Over the last 20 years (ending in 2017), the correlation between the two has been -0.66 based on total annual returns, an exceptionally negative correlation. For 2008 to 2017, specifically, it produced a -0.78 correlation.

Worth noting: The prior peak for 10-year stock-bond correlations was back in 1964, at -0.64.



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