Is the 60/40 portfolio still relevant?

How have different portfolio allocations developed world wide?

Amid the recent market turmoil the worst 12 months ever for US bondsThis is especially a critical query given persistent inflation and the looming threat of slower growth and even recession Given the present debate concerning the effectiveness of the normal 60/40 portfolio. To answer this query, we evaluate the performance of portfolios with 100% stocks, 100% bonds, 60/40 and 80/20 asset allocations within the US, UK, Italy, Switzerland and global markets over time, each across the board and across the board also dollar-cost averaging (DCA) basis.

We selected these markets because they’ve widely available liquid instruments to implement our strategies in addition to various levels of volatility.

With the exception of world bond allocation, we construct all of our hypothetical portfolios using exchange-traded funds (ETFs). We collected current price data for the ETFs and NAVs for the worldwide bond fund and reinvested/amassed the dividends over our ten-year holding period from December 31, 2012 to December 31, 2022. Each country’s funds are valued in local currency and world funds in US dollars. The only Swiss bond ETF with a 10-year return history had a goal term of seven to fifteen years.

Components of the portfolio strategy

We backtested and calculated the annual total return of every strategy using an investment of 120,000 in local currency. With the lump sum approach, we invested the whole 120,000 on December 31, 2012. In the DCA approach, we divided the overall investment into 1,000 local currency money flows every month for 120 months, from December 31, 2012 to December 31, 2022.

We excluded transaction costs because they’re more likely to be low with the flat-rate strategy and more likely to be higher with the DCA method, but shouldn’t affect the standard of our results.

Annualized return development: lump sum vs. DCA

The annualized returns for the flat-rate approach in each country and the world portfolio shown within the chart below show that only the 100% U.S. equity portfolio performed higher than the 100% global equity portfolio, while the 100% bond portfolios of all 4 countries outperformed her World colleague. Each 80/20 allocation produced higher returns than its 60/40 competitors in the identical market.

Flat rate annualized returns

The US stock market initially had relatively high returns in comparison with those of the opposite three countries, and all US portfolios except the 100% bond allocation performed well. However, these results have one major caveat: they depend upon our exact 10-year time-frame and can’t be generalized outside the sample. Furthermore, not all investors, whether private or institutional, take a blanket approach in the buildup phase. This is why we conducted our DCA evaluation.

How has the DCA strategy performed as compared? All 4 country markets exhibit similar trends, as shown within the chart below: All 100% bond allocations had negative annual returns. Only 100% US stocks outperformed 100% world stocks. As with the blanket evaluation, 80/20 portfolios outperformed 60/40 portfolios.

Dollar-Cost Averaging Annualized Returns

Comparison of holding periods

To isolate the impact of the dismal 2022 bond yields, we ended the holding period on December 31, 2021 as an alternative of December 31, 2022 and reduced our investment amount from 120,000 to 108,000. This increased the general annualized returns for bonds and stocks for the DCA approach. The 100% US equity strategy improved essentially the most, producing a 6.56% higher return.

How did the flat rate strategy perform in each holding periods for a 100% equity allocation and a 100% bond allocation in each country? The graphic below distills our results.

Flat rate: 100% stocks vs. 100% bond portfolios

For comparison, the next visualization shows how the 60/40 and 80/20 allocations in each market performed over each time windows.

Each category’s equity and bond funds, in addition to all 60/40 and 80/20 portfolios, had significantly higher returns when the holding period ended on December 31, 2021, quite than December 31, 2022.

Flat rate: 60/40 vs. 80/20 portfolios

volatility

Using the common monthly returns, we calculated the usual deviation of every strategy and multiplied it by the square root of 12 to annualize it. The standard deviations of funds in each category increased in 2022 as volatility increased in stock and bond markets worldwide, as shown within the table below.

Standard deviations

Italian stocks have essentially the most volatility and British and Swiss stocks have the least volatility, while the volatility of US stocks is closely correlated with international stock volatility. The bond markets within the USA and Switzerland were essentially the most stable.

Sharpe ratios

To understand the risk-adjusted returns of every strategy, we calculated their Sharpe ratios. For the risk-free rate, we use the country’s average 10-year Treasury rate and the common 10-year U.S. Treasury rate for the worldwide portfolios since they’re denominated in U.S. dollars. Our results over the 2 time samples, shown within the two charts below, show that every one Sharpe ratios for the period ending in 2021 are higher/higher, except the Italian 80/20 portfolio. This suggests that global equity and bond markets performed higher on a risk-adjusted basis in 2021 than in 2022.

Compared to the 100% global equity allocation, US and Swiss stocks had higher Sharpe ratios over each periods and their UK and Italian counterparts had lower ones. The 100% bond allocations in all 4 countries had higher Sharpe ratios than their global counterparts.

Sharpe ratios as much as 2021

Sharpe ratios until 2022

When the holding period led to 2021, the 60/40 portfolios had higher Sharpe ratios than the 80/20 portfolios. At the top of 2022, all 80/20 portfolios except Switzerland had higher Sharpe ratios. Since the risk-adjusted performance of bonds was worse than that of stocks over this era, allocating a better percentage to bonds – 40% to simply 20% – resulted in worse results.

The Sharpe ratio of the worldwide 80/20 portfolio was higher than the 60/40 values ​​in each time samples, but particularly within the time sample ending in 2022. The higher volatility, high inflation and rising rate of interest environment in 2022 clearly sabotaged bond performance and played an outsized role in our results.

looking ahead

What are the findings from this evaluation? First, the flat rate method performed well in all markets and portfolios that allocated to stocks. Of course, such a way requires a lump sum investment, and success depends partially on market timing. Additionally, investors could also be emotionally reluctant to speculate a lump sum during a market downturn. The DCA approach, alternatively, smoothes the impact of market fluctuations on the portfolio, thereby reducing timing risk.

Based on flat Sharpe ratios, the 100% equity portfolio had one of the best risk-adjusted performance in all markets except Italy through 2022. For the period ended December 31, 2021, the 60/40 allocation performed best on a risk-adjusted basis in each country, but not globally. The 80/20 allocation performed higher than 100% stock and 100% bond allocations in some markets and worse in others. Overall, the bond catastrophe of 2022 has dragged down annualized and risk-adjusted returns.

Further research is required to attract further conclusions concerning the utility of the 60/40 portfolio in comparison with the 80/20 portfolio or another allocation strategy. In fact, our colleagues are in the midst of implementing it. But as our evaluation shows, a portfolio redeemed at year-end 2021 would have performed higher than the identical portfolio redeemed at year-end 2022. This is a superb reminder of the chance of endpoint bias in any time series evaluation.

Of course, our study has limitations beyond those mentioned above. It doesn’t take into consideration the impact of foreign currency conversions, focuses exclusively on developed markets and has a shortened investment period. Still, it provides insight into the impact of various asset allocation strategies during the last decade, showing how the 60/40 portfolio can contribute to risk-adjusted returns and the way outlier years can hurt performance.

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Photo credit: ©Getty Images / alexsl