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Don't Kill the 60/40 Portfolio: Vanguard Consultant

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What You Need to Know

  • Vanguard consultant Matthew Sheridan offers multiple reasons to stick with this traditional allocation.
  • Adding cash to create a 60/30/10 portfolio won't boost returns, according to a 10-year forecast.
  • Investors should consider tweaking their stock allocations instead.

The 60/40 stock and bond portfolio is not dead, so advisors should not try to kill it or bulk up on higher yielding, riskier fixed income assets, according to Vanguard investment consultant Matthew Sheridan.

At a recent webinar hosted by Dave Nadig, chief investment officer and director of research at ETF Trends, Sheridan, who works with financial advisors, compared a 60/40 stock and bond portfolio to the typical advisor portfolio of 60% stocks, 30% bonds and 10% cash to lower the duration, or interest rate sensitivity, of the portfolio as rates rise.

The cash is usually paired with a U.S. home bias and relative overweights in small-cap stocks, short-term credit, high-yield bonds and emerging market debt, Sheridan said. More recently, the fixed income allocation includes less liquid but higher yielding assets like bank loans and convertibles, which have higher yields than other fixed assets, according to Sheridan.

Looking forward over the next 10 years, the Vanguard model shows almost the same annualized return for the two portfolios — around 4.08% — but the typical advisor portfolio has a lot more volatility — 10.11% vs. 9.20%. The primary reason is client behavior in response to the more volatile portfolios, Sheridan said.

Stocks vs. Bonds During Downturns

He also looked back at the performance of stocks and bonds during the double-digit stock market downturns that occurred in the fourth quarter of 2018 and the first quarter of 2020. In both downturns, U.S. and non-U.S. investment-grade bonds appreciated, while U.S. and non-U.S. stocks and U.S. high-yield bonds lost value.

“We do not believe the 60/40 portfolio is dead at this point. There are periods when equities fall 4%, 5%, 7% and bonds might move off, but when equities drop 20% or 30%, that’s when … having allocation to investment-grade credit or government bond credit will play a solid role in portfolio construction moving forward.”

Sheridan recommended that instead of adding less liquid fixed income assets to portfolios to increase income, advisors make small changes to clients’ equity portfolios, adding more international stocks, which are now returning about 3% more than U.S. stocks, and more value stocks, also returning 3% to 7% more. A 20% to 30% allocation to international equities is the “sweet spot” to reduce volatility, said Sheridan.

Don’t Fret Over Rising Rates

The Vanguard consultant acknowledged the low income that bonds can provide in the current market and the price declines in bonds that will come if rates rise but said “that doesn’t mean that you shouldn’t have [bonds] in a portfolio for your clients. As rates rise … bonds are becoming more advantageous from a portfolio construction landscape … you’re going to get yields that catch up with the [rate] moves.”

As a rule of thumb, he added, “As long as the client’s time horizon is longer than the duration of their portfolio rising rates will be beneficial to that client.” In addition, Sheridan notes, “the diversification benefits of owning bonds actually increases because the duration elements are changing within that portfolio.”

Within stock allocations, he said value stocks will outperform growth by 5% to 6%, but most U.S. portfolios are still underweight in value stocks.

(Image: Adobe Stock)