Times are a-changin’, but strategies remain constant. One of the more effective strategies from the 1970s and 1980s was the 60/40 split between stocks and bonds. But is that same strategy still effective today? Or is the concept of diversification the underlying prize of the party?
The 60/40 rule promotes that investors best prepare themselves for long-term success by allocating 60% of their portfolio into stocks (equities) and 40% into bonds (usually treasuries). The 60/40 is especially powerful if used with the 4% withdrawal strategy.
Now, when the 60/40 rule was created, the yield of treasuries was over +10%. Investors were able to get decent returns with little risk in the stock market. People used the stock market as the growth element of the portfolio and bonds as fixed income.
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When using the 60/40 rule, investors would use bonds for income and liquidate stocks as they outperformed the market. They would only have to sell stocks in the best of times.
The bond element also serves as psychological reinforcement during market downturns. When the market goes sour, your bonds will remain steady and continue to provide you income. Bonds did not trade on the stock market, thus were not susceptible to market volatility.
So what changed? As the Federal Reserve continued to involve itself in the markets, bond yields plummeted. The current yield on the 30-year Treasury bond is 2.00%—and it was much lower than this last year.
With inflation running hot right now, at +5.0% consumer price index inflation over the summer of 2021, the 30-year bond has a negative return. For the 60/40 rule to be effective, bonds would need to at least equal inflation but preferably beat inflation slightly.
As bond yields decrease, investors take on riskier investments to obtain a livable yield. If core inflation is over 5%, we must look for high yield products like closed-end funds for long-term success.
Bonds are trash. Treasury bonds are trash right now, against the backdrop of high inflation. However, you can still get decent returns from bonds with bond funds. Bond funds trade on the stock market as ETFs and can obtain better returns than standard treasuries.
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Trading on the stock market is a double-edged sword, as now your bonds are susceptible to the whims of the market. If there is a market sell-off, your bond fund will likely sell-off with the rest of your equities. However, based on market conditions, it may recover faster as more people flee to safety.
If you have a long time horizon, the ups and downs of the market will flatten to give you excellent returns. As we age and get into our 60s and 70s, we want less volatility. Usually, that means that we start to move more into fixed-income products. But, what should we do when treasuries yield nothing?
Look at bonds as a cash substitute. During the reign of the 60/40 rule, investors viewed bonds as an investment instrument. Today, we should view bonds as a cash substitute. Bonds give us a better yield than cash.
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How much cash should you keep on hand to hedge against market turmoil? Most people say to hold 6-12 months of living expenses. So maybe you keep three months in cash and nine months in bond funds. That way, you are at least getting a little yield from a large amount of cash.
I keep roughly $16,000 of my $195,000 portfolio in Treasuries and bond funds. However, I am relatively young and have a steady military paycheck. As I age, I may want to go heavier into fixed income sources.
The bigger picture. As much as I would love for the stock market to solve my problems, I turn to a total life approach to wealth. Yes, the 60/40 rule is dead in the current climate. Bond yields are too low, and the Federal Reserve is pushing us into riskier assets.
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Investors need to look beyond the stock market to achieve consistent returns to hedge against the wealth destruction inflation causes. There are other ways to beat inflation using creativity, business, cryptocurrencies, and rental income.
The best way to beat inflation is to make more money! We no longer have the option of trying to beat inflation with stocks and bonds alone. Sure, income investing and dividend growth investing are great ways to keep up and beat inflation. But, adding in a couple of rental properties will juice your total returns in the long term.
Know your income goals. The best way to beat inflation is to understand your budget for expenses and how much income you want to achieve. Wealth is having excess income vs. expenses.
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If your expenses are $2,000/month, you can beat inflation by attempting to stick to this number. The harder you try to stay at this number, the better you beat inflation. Your lifestyle may change—less shopping, vacations, or amenities—but you are preparing for success in the long term.
As your expenses stay at $2,000/month, you want to earn $6,000, $7,000, $8,000/month. You want to push your income as high as possible and reinvest the difference. You never want to stop pushing your income. If you can keep this mindset, you will destroy inflation and become rich.
Conclusion. Yes, the 60/40 rule will yield you poor returns in its current state—bond yields are way too low. If the Federal Reserve starts raising interest rates to slow inflation, then maybe we can re-address the 60/40 rule. I wouldn’t hold my breath for living bond yields in the next 4-6 years, though.
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The purpose of the 60/40 rule was to smooth out returns and flatten out volatility. It kept investors from making rash decisions during market downturns. When you are 100% invested in stocks, your livelihood flows on the ocean of volatility.
Today’s best approach is to keep cash and cash-like equivalents to prevent you from panicking during a downturn. Also, invest in other off-market assets that rise with inflation, such as real estate, cryptocurrencies, gold, etc. Adding a small business or income from royalties is the icing on the cake.
I am a huge fan of total life returns, not just from one asset class. The bigger the picture, the better the returns. Please follow me on Twitter and my Facebook Page for more investing knowledge. Enjoy and Happy Investing.
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