Low Interest Rates: Is the 60/40 Portfolio Still Best?

With interest rates at record lows, many analysts are questioning the benefits of running the classic 60%/40% (equity to fixed) balanced portfolio. 

The historical argument for such a portfolio hinges on the non-correlated performance of stocks and bonds. During times of equity drawdowns, fixed income securities typically provided offsetting positive performance, so over time the total portfolio return volatility has been lower versus a 100%/0% (all-equity) portfolio. 

The resultant Sharpe ratio (return divided by risk) has accordingly been higher for the 60%/40% portfolio versus the 100%/0% portfolio and certainly the 0%/100% portfolio.

The illustration is a 120-year snapshot of the Sharpe ratio for the 60%/40%, 100%, and 0%/100% (all fixed income) portfolios. Data is presented for monthly returns on a rolling 10-year basis.

As shown, generally the 60%/40% portfolio provided better return vs. risk performance versus the other two for much of this very long period. There were periods where it was neck-and-neck for the first two though, as in the stretch from 1960-1980.

But certainly since 1980 until roughly now, the 60%/40% portfolio has provided for a definitely higher Sharpe ratio compared to either a 100%/0% or 0%/100% portfolio.

Breakdown

So, the key argument from the “balanced bear scare” proponents currently is that the negative equity/bond correlation that has been so prevalent over much of history will finally break down, given the exceptionally low bond interest rates presently. 

Hence, they argue, the risk-adjusted return benefit of a 60%/40% portfolio will go away, providing investors with a confused roadmap going forward.

Whether this scenario does indeed play out remains to be seen. It is probably safe to say, however, that a breakdown in this long-held portfolio management principle could cause irrational investor behavior both within and across asset classes as investors adjust.

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Gary has more than 30 years of industry experience, which includes research analysis and portfolio management for both retail and institutional accounts. He worked as a Senior Vice President at Wells Fargo Advisors and Wells Fargo Investment Institute for approximately 14 years in total, where he was a senior portfolio manager for both equity and asset allocation portfolios. He was also involved in investment manager due diligence and selection for the firm’s multi-manager portfolio models. Prior to joining Wells Fargo, Gary held senior-level investment management positions with several registered investment advisory organizations. He has been a Chartered Financial Analyst (CFA®) charter-holder since 1989. The CFA is a professional credential earned by investment management professionals after successfully passing three years of rigorous examinations and recording several years as a practising professional within the industry. Gary received his Bachelor of Science in Engineering from Purdue University and his M.B.A. in Finance from The University of Missouri. Additionally, Gary holds his FINRA SIE, Series 7 and Series 66 securities registrations as well as his Missouri Life Accident & Health insurance license. He is a member of the CFA Society of St. Louis and the Financial Executives Networking Group. He resides in Kirkwood, MO with his wife Kathy, and they have three adult age children, Aly, Ryan and Josh.