The stock market is a system that tends to follow tradition. Traditionally, investors have been expected to start young, build a buy-and-hold portfolio, and be careful with asset allocation in order to avoid high levels of risk.
Much has changed in investing over the past couple of decades with robo-advisors making moves for many investors, access to the market widely available through discount brokers, and a rise in short-term trading.
Still, many people feel more comfortable investing in the traditional ways, which is what makes the highly traditional 60/40 portfolio so popular.
Read on to learn about the 60/40 portfolio model, how to build one for yourself, and its pros and cons.
What Is the 60/40 Portfolio?
The 60/40 portfolio has been around for decades and is more of an investment strategy than a defined portfolio because there are no assets set in stone that build up the portfolio.
The strategy is based on a safe asset allocation strategy that has been used in retirement accounts for so long that it’s hard to pin down where it started or who first developed it.
The other 40% of the portfolio’s assets should be invested in fixed-income securities like U.S. Treasury bonds, corporate bonds, and other debt securities that produce income through interest rates or a discount on the price of the security.
The idea is that by diversifying your portfolio across asset classes that experience different levels of volatility and risk, you’ll be able to access the gains the stock market provides during bull markets while minimizing losses during downturns or all-out bear markets.
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The Investment Thesis Behind the 60/40 Portfolio
The 60/40 portfolio is based on a strategy of diversification that many believe provides the perfect balance between risk and reward. The thesis is simple.
Most experts agree that it’s nearly impossible to time movements in the stock market, but they also agree that by avoiding stocks altogether, you’re robbing yourself of the opportunity to produce significant returns. Despite their inherent volatility, it’s important to maintain exposure to the stock market while working to balance the risk of those equities falling on hard times.
That’s where fixed-income securities come into play. These investments come with significantly lower risk. Once these securities mature, investors are paid back their entire initial investment amount.
The interest payments received throughout the life of the investment (or the difference between the price of buying the security and the price paid at maturity) acts as the return.
Who Should Take Advantage of the 60/40 Portfolio?
Because the 60/40 portfolio is highly customizable, it’s a great fit for just about any investor. As you’ll learn, the portfolio can be adjusted for different risk levels and investment strategies.
However, there is one concern with the portfolio. The strategy is based on a strict asset allocation of 60% equities and 40% fixed-income investments. However, many experts disagree on what an optimal asset allocation looks like.
Because your goals and appetite for risk are likely to change over time, many suggest using your age to determine the split between equities and fixed-income investments.
For example, instead of allocating 40% of your assets to bonds and other debt securities and 60% to equities in all cases, this variation on the strategy suggests if you’re 21 years old, you should allocate 21% to fixed-income securities and 79% to equities.
This variation involves adjusting your holdings as you age to include more fixed-income assets and fewer equities, becoming more conservative as you near retirement.
Ultimately, a 60/40 portfolio is a traditional, moderate-risk portfolio that could result in slower growth than other options. By following the 60/40 portfolio to the letter, your risk may be too heavily moderated or too aggressively accepted, depending on your age and investment goals.
Pros and Cons of the 60/40 Portfolio
As with any other portfolio strategy, there are pros and cons that should be considered before diving into the 60/40 portfolio.
60/40 Portfolio Pros
There are several reasons to consider following the 60/40 strategy in your own portfolio. Some of the most exciting aspects of the portfolio include:
- Diversified to the Max. The portfolio, although made up of only a few assets at most, is designed to be highly diversified, offering complete exposure to whichever sector of the market you prefer. The mix of underlying assets in each fund acts as an insurance policy against volatility.
- Fully Customizable. The portfolio doesn’t outline the exact funds you should invest in, just that 60% of your investments should be in equities and 40% should be in fixed-income assets. This leaves you the option to choose the investment strategy, level of risk, and asset exposure of the funds you buy within the predefined allocation. Few portfolios offer this level of customization.
- Evenly Balanced Risk. Through the strict asset allocation rule, risk is evenly balanced. While there are opponents to the idea of fixed allocation, this is a tried-and-true strategy that’s been used for decades.
- Easy Management. Finally, there are very few assets to keep track of here. This makes maintaining balance and managing your portfolio an extremely simple process.
60/40 Portfolio Cons
While there are plenty of reasons to be excited about deploying this portfolio strategy, there are also a few drawbacks that should be considered before diving in. They include:
- Fixed Allocation. Asset allocation is fixed at 60% stocks and 40% bonds, which is rather modest for younger investors and a bit risky for those nearing retirement. Most financial advisors suggest following a fluid allocation strategy that changes as your risk tolerance and goals change.
- Low Bond Yields. In recent years, the market has been experiencing historically low bond yields as a result of a low-interest-rate environment. By allocating such a large percentage of your portfolio to fixed-income investments, you could be missing out on much of the gains the bull market has to offer.
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How to Duplicate the 60/40 Portfolio
As mentioned above, the contents of a 60/40 portfolio aren’t set in stone. It’s more of a guide explaining how you may want to go about asset allocation that can be applied to several different investment strategies.
As a result, there are several ways to go about building the portfolio — a task made easier by the abundance of low-cost ETFs on the market today.
Here are six popular ways to build a 60/40 portfolio for yourself based on your investing strategy and risk tolerance. The funds mentioned here are low-cost Vanguard index funds, but you can choose any fund you like that gives you exposure to the same types of assets.
The Low-Risk 60/40 Portfolio
For investors with a low risk tolerance who want access to the market as a whole, the build of the portfolio is best as follows:
- 60% in Vanguard Total Stock Market Index Fund ETF (VTI). One of the most diversified ETFs on the market today, the VTI is designed to give investors exposure to the total United States stock market. The past performance of the fund has been stellar, beating others in its category relatively regularly over the past 10 years.
- 40% in Vanguard Intermediate Term Treasury ETF (VGIT). The VGIT is focused solely on intermediate-term, high-quality U.S. Treasury securities. While these government bonds come with relatively low yields compared to longer-term options, their yields are stronger than short-term bonds and liquidity is reasonable.
The Moderate-Risk 60/40 Portfolio
While the low-risk 60/40 portfolio is a great option for many, investors know that the lower the risk associated with the investment, the lower the potential for gains.
One great way to slightly increase the risk while greatly expanding your earnings potential when using this portfolio strategy is to include international stocks in your equity holdings and swap out Treasury bonds for corporate bonds in the bond portion of the portfolio.
Here’s how that looks:
- 60% in Vanguard Total World Stock ETF (VT). The VT ETF fund was designed to provide exposure to a highly diversified list of stocks, both in the U.S. and around the world. While the international side of the portfolio increases the risk, it also increases potential profitability, as emerging market growth tends to outpace growth in established markets like the United States.
- 40% Vanguard Total Corporate Bond ETF (VTC). On the bond market, corporate bonds are known for paying higher yields than Treasury bonds but do come with increased risk. By investing in the VTC fund rather than VGIT, it’s possible to increase the earnings on the fixed-income side of your portfolio.
The High-Risk 60/40 Portfolio
Finally, if you’re willing to accept higher levels of risk, the potential returns of the 60/40 portfolio can be increased by including some different asset classes into both the equity and fixed-income sides of the equation.
Among your equities, consider mixing in some small-cap holdings. Small-cap stocks are known for high levels of volatility and risk, but they’re also known for the potential to outpace the returns of their large-cap counterparts.
On the fixed-income side, look into real estate investment trusts (REITs). These real estate investments are riskier than bonds but have much greater potential to increase your profitability while providing a source of predictable returns in the form of exceptional dividends.
Adjusting the portfolio for a high-risk investor is as simple as investing in the following funds:
- 30% in Vanguard Total World Stock ETF (VT). The VT fund remains an anchor in this investing strategy, providing access to a diversified group of U.S. and international holdings. This fund should represent about 30% of your holdings in the high-risk rendition of the 60/40 portfolio, or half of your equity allocation.
- 30% in Vanguard Small-Cap ETF (VB). The VB fund is made up of a diversified group of small-cap stocks, providing exposure to high-growth opportunities in smaller companies. This fund takes the other 30% allocation on the stocks side of the portfolio in this model.
- 20% in Vanguard Total Corporate Bond ETF (VTC). About half of your fixed-income allocation, or 20% of the total portfolio, should be invested in the VTC fund to gain exposure to corporate bonds.
- 20% in Vanguard Real Estate ETF (VNQ). Finally, the VNQ fund is an index made up of investable REITs, which gives you broad access to real estate investments while maintaining diversification within the asset class. This fund takes up the other half of your fixed income allocation, representing 20% of the portfolio.
The Growth 60/40 Portfolio
If you’d rather focus on a growth strategy than simply making bucket investments in diversified groups of equities, the growth 60/40 portfolio is the way to go. Here’s what it looks like:
- 60% in Vanguard Growth Index Fund ETF (VUG). The VUG fund was designed to provide diversified exposure to U.S. large-cap growth stocks. These are companies that have a proven history of generating significant growth, but provide a level of safety in that they are all large-cap, established companies. In the growth rendition of the portfolio, this fund represents 60% of your investment allocation.
- 40 % Vanguard Intermediate-Term Treasury ETF (VGIT). The other 40% of the portfolio would be invested in the VGIT, offering stability through intermediate-term Treasury securities.
The Value 60/40 Portfolio
If you’re following a value investing strategy, the best way to take advantage of this portfolio is to invest the stock portion of your assets into a value-centric fund like the Vanguard Value Index Fund ETF (VTV).
This fund provides diversified exposure to large-cap value stocks, meaning these are large-cap companies with valuation metrics that suggest they’re trading at a discount.
You can then invest the remaining 40% of your assets using the VGIT for your bond holdings.
The Income 60/40 Portfolio
Finally, those focused on income investing can also take advantage of this portfolio with one small tweak. As with the traditional 60/40 portfolio, 40% of your assets should be allocated to the VGIT, providing safety through investments in intermediate-term Treasury securities.
The other 60% of the portfolio should be invested in the Vanguard High Dividend Yield ETF (VYM). The VYM is made up of a wide range of stocks known for paying high dividend yields.
By investing in the fund, you’ll gain diversified exposure to stocks of all sizes in various sectors that all have one thing in common — they all have a history of offering investors a high dividend yield. That’s music to an income investor’s ears.
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Keep Your Portfolio Balanced
Regardless of which rendition of the 60/40 portfolio you choose to go with, it’s important to make sure to maintain balance. The entire thesis behind the portfolio is to provide meaningful returns while creating a safety net by balancing higher-risk equities with lower-risk fixed-income investments.
As time passes, some investments will rise in value and others may fall. As a result, your investment portfolio will fall out of balance. If the balance becomes too skewed, the portfolio may fail to meet your investment objectives.
The good news is that the 60/40 portfolio strategy is a buy-and-hold strategy, meaning you won’t be required to rebalance your portfolio monthly. However, it is best to take a look at your portfolio on at least a quarterly basis.
Moreover, with so few assets, maintaining balance is a relatively simple process. When one asset grows to take up more than its allotted percentage, simply sell a little of it and buy more of its counterpart to bring the portfolio back to the 60/40 balance.
There’s a reason the 60/40 portfolio is one of the most talked-about strategies on Wall Street. For decades, investors have been deploying this strategy, which has worked to build wealth over time.
However, as times change, the traditional investing models are being replaced with newer, more fluid options. While the traditional 60/40 concept has been a go-to for some time, it’s not the best fit for all investors, nor is it optimized for investing during a bull market where bond yields are chronically low and stocks are on the rise.
Nonetheless, when markets are flat or falling bearish, and you feel a safer approach is best, the portfolio is a great fit. Moreover, if you’re willing to take the time to customize and are interested in REITs rather than heavy bond allocation, the portfolio can be adjusted to fit your needs.