Investments

What Is 60-40 Portfolio

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 10 minute read

As a system, the stock exchange has a penchant for sticking to established norms. There has long been the belief that in order to reduce exposure to risk, investors should begin their activities at a young age, construct a buy-and-hold portfolio, and use caution while allocating their assets.

Over the past two decades, the investment industry has seen significant upheaval due to the rise of Robo-advisors, the widespread availability of market access through discount brokers, and the popularity of short-term trading.

However, many investors are more at ease with tried-and-true methods, which explains the 60/40 portfolio’s enduring popularity. Keep reading to find out what the 60/40 portfolio model is, how to construct one, and the benefits and drawbacks of using it.

About 60/40 Portfolio

The 60/40 portfolio, which has been around for decades, is more of an investment strategy than a strictly defined portfolio because its components are not predetermined. The plan is based on a conservative asset allocation method that has been employed for pension funds for so long that its origins and creators are obscured.

As recommended by the 60/40 portfolio plan, you should have 60% of your money in equities like stocks, ETFs, and mutual funds. U.S. Treasuries, corporate bonds, and any other debt securities that generate income via interest rates or a discount on the price of the security should make up the remaining 40% of the portfolio.

The premise behind diversification is that it allows you to take advantage of the stock market’s upswings and protects you from the market’s inevitable downturns and bear markets.

The 60/40 Portfolio’s Investment Thesis

Many investors believe that the 60/40 portfolio strikes the ideal balance between risk and reward since it is built on a strategy of diversification. In other words, the thesis is straightforward.

Most market experts agree that it’s extremely difficult to predict the direction of the stock market, but they also believe that you’re missing out on a great potential to make a lot of money if you stay completely out of the stock market. 

Maintaining stock market exposure necessitates juggling the potential for loss with the potential for gain due to the market’s inherent volatility. Here is where fixed-income investments come into play. 

The risk associated with these investments is much smaller. When these securities reach maturity, investors receive a full return on their initial investment. The return is the total amount of interest earned on an investment or the difference between the purchase price and the redemption price of a security.

Who Should Profit from a 60/40 Portfolio?

The 60/40 portfolio can be adjusted to meet the needs of almost any investor. As you’ll see, the portfolio may be modified to suit a variety of investment horizons and comfort zones. On the other hand, the portfolio does have one major flaw. 

There is a tight 60:40 split between equity and fixed-income investments that forms the basis of the strategy. However, there is a lot of debate about what exactly constitutes a good asset allocation amongst specialists.

To account for the fact that your needs and comfort level with risk may evolve with time, many financial experts recommend basing your investment allocation on your age.

For example; if you’re 21, instead of putting 40% of your money into bonds and other debt securities and 60% into stocks, this method would have you put 21% into fixed-income securities and 79% into stocks.

In this variant, investors grow more conservative as they approach retirement by shifting their portfolios toward fixed-income assets and away from equities.

A 60/40 portfolio is a safe, moderate-risk choice that may grow more slowly than more aggressive strategies. Depending on your age and financial objectives, strict adherence to the 60/40 portfolio could lead to either too little or too much risk-taking.

The advantages and disadvantages of a 60/40 Portfolio

Before committing to a 60/40 portfolio, it’s important to weigh the benefits and drawbacks, just as you would with any other investment approach.

60/40 Portfolio Advantages

The 60/40 portfolio split has a number of advantages and could be a good choice for your personal investments. 

The portfolio’s most interesting features are:

  1. Maximum diversification. The portfolio may just consist of a handful of assets, but it is built to be extremely diversified so that you can gain exposure to any market segment you like. Each fund’s diversified portfolio of underlying assets provides a buffer against market swings.
  2. Absolutely Modifiable. The portfolio doesn’t specify any particular funds to buy, only that 60% should go toward stocks and 40% toward fixed-income investments. Within the bounds of the predetermined allocation, you can pick and choose which funds to purchase, giving you control over their investing strategy, risk profile, and asset exposure. This level of personalization is uncommon among portfolios.
  3. Proportionate Danger. Adhering to the rule of thumb for asset allocation helps spread out risk. Even though some people may disagree with the concept of fixed allocation, it is important to remember that this method has been employed successfully for decades.
  4. Simple Administration. When all is said and done, there aren’t many assets here to track. Because of this, managing your portfolio and keeping it diversified is a breeze.

Disadvantages of a 60/40 Portfolio

In spite of the many advantages that may be gained by implementing this portfolio approach, there are also some disadvantages that should be thought through first. 

For example,

  1. Having a set amount. The fixed asset allocation of 60% stocks and 40% bonds is conservative for younger investors but dangerous for those on the cusp of retirement. Most experts in the field of finance will advise you to adopt a strategy of dynamic asset allocation, which will evolve in line with your risk tolerance and long-term objectives.
  2. Feeble Bond Returns. Bond yields have dropped to record lows in recent years due to the historically low-interest rate environment. You may be missing out on the bull market’s profits by dedicating a substantial portion of your portfolio to fixed-income securities.

How to Make a Second 60/40 Portfolio

A 60/40 portfolio’s components are not set in stone, as was previously mentioned. It’s more of a guide detailing some potential ways to approach asset allocation that may be used with a variety of investment approaches.

With so many inexpensive exchange-traded funds (ETFs) available, it’s possible to construct a portfolio in a variety of ways.

You can tailor a 60/40 portfolio to your investment style and comfort level by choosing from the six methods outlined below. Though we recommend low-cost Vanguard index funds, you are free to invest in any fund that offers similar exposure to the markets.

The Risk-Adjusted 60/40 Portfolio

The following portfolio construction is recommended for investors with a low-risk tolerance who want exposure to the entire market:

  • Sixty Percent Invested in Vanguard’s Total Stock Market Index ETF (VTI). The VTI is one of the most diverse exchange-traded funds (ETFs) available today because it is meant to provide investors with exposure to the whole U.S. stock market. The fund has a remarkable track record, consistently outperforming its peers over the past decade.
  • Vanguard’s iShares Intermediate-Term Treasury ETF accounts for 40% of the portfolio (VGIT). The VGIT invests exclusively in high-quality U.S. Treasury securities with a maturity of three to ten years. Although the returns on these government bonds are lower than those on some longer-term choices, they are higher than those on some short-term bonds, and their liquidity is enough.

The 60/40 Portfolio with Moderate Risk

The 60/40 portfolio, with its relatively low level of risk, is appealing to many people. However, savvy investors know that the lower the level of risk, the smaller the possible reward.

By diversifying your portfolio by adding overseas companies to your equity holdings and switching out your Treasury bonds for corporate bonds, you can enhance your risk tolerance while also increasing the possible return on your investment.

This is how it would appear:

  • Investing 60% of Available Funds in Vanguard’s Total World Stock ETF (VT). The VT ETF fund was created so that investors may gain access to a wide range of stocks from the United States and throughout the world. Incorporating a global perspective into the portfolio raises the stakes, but it also raises the stakes for possible profits, as emerging markets are expected to grow at a faster rate than more mature economies like the United States.
  • 40 Percentage of Vanguard’s Total Corporate Bond ETF (VTC). Corporate bonds are a popular investment option since they offer larger returns than Treasury bonds do, albeit at a higher risk. You can boost your fixed-income portfolio’s returns by investing in the VTC fund rather than VGIT.

The 60/40 High-Risk Portfolio

Finally, the potential returns of the 60/40 portfolio can be boosted by integrating some alternative asset classes in both the equities and fixed-income sides of the equation, but only if you are willing to tolerate higher levels of risk.

You should diversify your equity portfolio by including some small-cap stocks. Although small-cap stocks tend to be more volatile and risky than their large-cap counterparts, they also have the potential to produce higher profits.

Real estate investment trusts are a good option for those interested in stable income (REITs). These real estate investments have a higher level of risk than bonds, but they also have the potential to boost your profits and provide a reliable source of income through extraordinary dividends.

Adding the following funds would be sufficient to make the portfolio suitable for a high-risk investor:

  • Investing 30% of One’s Assets in the Vanguard Total World Stock ETF (VT). The Vanguard Total Stock Market (VT) Fund continues to be a cornerstone of this investment approach by providing exposure to a wide range of domestic and international securities. In the high-risk version of the 60/40 portfolio, this fund should account for roughly 30 percent of your holdings or 40 percent of your equity allocation.
  • 30 Percent Investment in Vanguard’s Small-Cap ETF (VB). The VB fund is composed of a wide range of small-cap equities, giving investors access to the potential for rapid expansion in a wide variety of businesses. In this example, the remaining 30% of the equity portion of the portfolio is allocated to this particular fund.
  • Funding of 20% in Vanguard Total Corporate Bond ETF (VTC). If you want to obtain exposure to corporate bonds, you should invest about 20% of your portfolio in the VTC fund, which is about half of your fixed-income allocation.
  • Investing 20 Percent of Money in a Vanguard Real Estate ETF (VNQ). Lastly, if you want to diversify your real estate holdings while still having broad exposure to the sector, the VNQ fund is an index composed of investable REITs that does just that. The remaining 20% of your fixed income holdings should be invested in this vehicle.

Growth 60/40 Asset Allocation

The growth 60/40 portfolio is the way to go if you want to put your attention on a growth strategy rather than making random investments in varied groups of equities. 

This is how it manifests itself:

  • Investment of 60% in the Vanguard Growth Index Fund Exchange Traded Fund (VUG). The VUG fund’s purpose is to offer investors a diversified way to get into large-cap growth companies in the United States. These are large-cap, well-established businesses with a history of considerable growth that also offer some security. This fund accounts for 60% of your portfolio’s total investment weighting in the growth version of the portfolio.
  • The Vanguard ETF for Intermediate-Term Treasuries constitutes 40% of the portfolio (VGIT). The VGIT, which holds intermediate-term Treasury securities, would account for the remaining 40% of the portfolio and provide stability.

The Value 60/40 Investment Portfolio

To get the most out of this portfolio, value investors should put their stock money into an exchange-traded fund (ETF) that focuses on value stocks, such as the Vanguard Value Index Fund (VTV).

Large-cap value stocks, or large-cap firms whose valuation criteria indicate they are trading at a discount, are the focus of this diversified portfolio. For your bond portfolio, you can put the remaining 40% of your assets into the VGIT.

The 60/40 Income Portfolio

Finally, with a single adjustment, this portfolio can also benefit income investors. The VGIT, which invests in Treasuries with a maturity date between the short and long terms, should account for 40 percent of your portfolio, much as the standard 60/40 split.

The Vanguard High Dividend Yield Exchange Traded Fund should make up the remaining 60% of the portfolio (VYM). The VYM consists of numerous equities that are renowned for their high dividend yields.

Fund investments provide a diverse portfolio of equities from a wide range of industries that have historically provided strong dividend yields to their shareholders. The words “income investor” are being sung.

Maintain Balance in Your Portfolio

No matter what variation of the 60/40 portfolio you wind up settling on, it’s crucial to stick to the rule of thumb of keeping everything evenly split. With a mix of riskier equities and safer fixed-income investments, the portfolio is meant to provide substantial returns while providing some measure of security.

Investing is a long-term game where some investments grow in value while others decline. Consequently, the overall composition of your investment portfolio will shift. A loss of equilibrium can cause your portfolio to underperform and prevent you from reaching your financial goals.

The 60/40 portfolio plan is a buy-and-hold approach, so you won’t have to worry about rebalancing your investments every month. However, you should review your portfolio at least once every three months.

Moreover, with so few assets, keeping the books balanced is a breeze. In the event that one asset class begins to dominate the portfolio, the 60/40 split can be easily restored by selling some of the offending asset class and reinvesting the proceeds in the other.

Bottom Line

The 60/40 portfolio is a popular investment strategy because of its relatively low risk/reward ratio. Investors have been using this technique, which has proven successful over the long term, for decades.

However, as the world evolves, conventional investment strategies are giving way to more flexible alternatives. Although the 60/40 approach has been popular for a long time, it isn’t suitable for all investors and isn’t designed for a bull market in which bond yields remain low and stock prices climb.

However, the portfolio is ideal if you choose a more conservative strategy during periods when the markets are either stagnant or declining. In addition, the portfolio can be tailored to your needs if you’re ready to put in the time to tweak it and are interested in REITs rather than a big bond allocation.

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