I was told to diversify my investments. Now I'm questioning the 60/40 strategy
The steady relationship between stocks and bonds to diversify and protect investments has broken down in rocky market conditions that show no sign of abating. And you would do well to ask a pertinent question before you update the mix, finance writer Dawn Cher says.
Do not put all your eggs into one basket but spread your money across stocks and bonds. It is a strategy that has been tried and tested, but there are times it may not work as well as it should. (Photo: iStock)
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When it comes to financial concerns of late, people are growing more worried about their investment portfolios turning red, as the war in Iran stretches into its seventh week with no apparent end in sight.
One question in particular that I've been seeing more often from friends and readers is this: Is the diversification strategy we've been following over the past 10 years still sound today? If so, then why has my portfolio not made money this year?
If you invest at all, you were probably taught the same thing I was when I was a beginner: Don't put all your eggs into one basket but spread your money across stocks and bonds.
This is a strategy that has long been tried and tested, and is often taught in investment textbooks.
The idea of achieving portfolio diversification via a 60 per cent allocation to equities and 40 per cent to bonds was first formalised by economist Harry Markowitz in 1952.
In simple terms, equities are shares you buy in a company, so your returns go up and down depending on how well the company performs.
Bonds, on the other hand, are more like lending money and getting paid interest in return, so they tend to be steadier but grow more slowly.
Banks and robo-advisory platforms continue to champion diversification in this form today, and understandably so.
But in a world where markets are becoming increasingly volatile and unpredictable, is it still worth believing in the often-preached 60/40 portfolio?
THE PROBLEM WITH 60/40
While some of my friends have adopted the 60/40 portfolio, I haven't.
Having never studied bonds well enough, it felt like too big a personal risk allocating such a significant portion of my money to them.
All the same, the 60/40 strategy's appeal is easy to see. Its strength lies in the key assumption that stocks and bonds will always behave differently.
For instance, if you owned shares in a company – Apple, for example – and bonds issued by the United States government, the long-held assumption was that even if one fell, the other would hold steady.
Historically, this assumption was often proven true.
For over a century now, the 60/40 portfolio has generally softened the blow of market crashes, with bonds acting as a buffer when stocks fall.
But this relationship has never been constant, nor is it guaranteed to be.
Before the late 1990s, bonds often failed to cushion equity losses.
During the 1970s, a period when the cost of almost everything kept climbing, inflation eroded the fixed returns on bonds, while rising interest rates dragged down stocks.
It didn't matter if you had a 60/40 split; both sides of your portfolio would've been battered at once.
Then came a decades-long stretch that made the 60/40 portfolio look almost foolproof. From the late 1990s to the start of the COVID-19 pandemic, the strategy steadily regained popularity and mass appeal.
That has since changed.
After the financial markets crashed in March 2020, not only did bonds fail to cushion the sharp drop in stocks, but they have also been underperforming compared to equities since 2022.
Morningstar, an investment research company, found that the crash of the 2020s was the only period since 1870 in which a 60/40 portfolio declined more severely than an all-equity portfolio. The finding is based on an analysis spanning 150 years.
Today, persistent inflation and higher interest rate hikes have caused both stocks and bonds to fall together, bringing us back to an uncomfortably familiar situation like the pre-1990s era.
History teaches us that there is a chance that a diversified portfolio today may no longer behave the way you think it will, or the way it did for your parents' generation.
We won't know for sure for a few decades – and by then, it'll be too late to change our financial strategy.
DIVERSIFICATION IS NOT WHAT IT USED TO BE
However, diversification isn't limited to the 60/40 portfolio. At its core, it simply means spreading risk across different asset classes and market exposures.
And if so, things are not so straightforward today.
Take the S&P 500, for example, an index that tracks 500 of the biggest companies in the US.
Investing in such a fund offers broad diversification across 500 companies. However, today, it's less diversified because more than 40 per cent of the stock performance comes from a small group of giant technology companies that dominate the index.
So investors who thought they were spreading their bets were just putting more of their money into these same few names without realising it.
Those who invested directly in these tech giants have done exceptionally well, while those who chose to maintain a broader diversification by picking up other funds not connected to information technology have lagged behind.
In short, a 60/40 portfolio today might look identical to the tools used from 20 years ago on paper – but what's inside it can be very different now.
Stocks have become more expensive and more concentrated today, and bonds no longer reliably cushion the blow when stocks fall.
Just because a strategy worked for the past few decades does not guarantee that it'll continue to work forever.
MODERN INVESTING IS CHANGING
Investors who relied on the 60/40 portfolio strategy, based on its historical performance, are starting to realise that their financial outcomes are not what they expected.
At the same time, financial institutions are also starting to sound the alarm bells that the 60/40 strategy may no longer be as safe as it once was.
Diversification still matters, but now, more people are starting to think that this needs to go beyond just stocks and bonds.
That is why interest has been shifting to gold, property or even commodities. These assets don't always get hit at the same time as the stock market.
As for bonds, we don't yet know whether they will fully regain their role as a cushion.
If inflation stabilises and interest rates normalise, their traditionally inverse relationship may return.
The point is, there is no way to entirely eliminate risk when we invest.
Here's the more fundamental question, though. Before you decide whether the 60/40 diversification strategy still holds for you, it's worth asking what you're trying to achieve.
After all, when you diversify, you are optimising for not losing too much. When you concentrate, you are optimising for the potential to win big.
Neither is right nor wrong. It simply depends on what you want.
If your goal is to keep up with markets over time while managing risk, diversification can still be a sound strategy.
If your objective is to significantly outperform the market, then diversification alone is unlikely to get you there.
Markets will always change. Relationships between assets will shift. No strategy is guaranteed to work all the time perfectly – not even the one that has worked for decades.
What matters more is building a portfolio that reflects your goals, your risk tolerance and your ability to stay invested even when things get uncomfortable, rather than simply following what you think is the "right" formula.
Dawn Cher, also known as SG Budget Babe, is the bestselling author of Take Back Control of Your Money. She has been running a popular blog on personal finance for the last 12 years.
