The 60/40 rule: An outdated rule that encourages investors to allocate 60% of their portfolio to higher-risk investments such as stocks, and 40% of their portfolio to lower-risk investments such as bonds.
Investors have been following this “rule” for decades, despite the fact that the ultra-wealthy are following a very different investing formula. If you take away one thing from this article today, let it be this:
The 60/40 rule is dead.
Why the 60/40 rule is outdated
A lot has changed in the marketplace since the origin of the 60/40 rule, decades ago.
In fact, according to Chief Global Strategist for J.P. Morgan Asset Management, David Kelly, a “plain vanilla” portfolio of 60% stocks and 40% bonds will likely net an annual return rate of just 4.2% over the next 10 to 15 years.
To compare that with the S&P 500 average annual return rate of about 10% since inception, that’s a pretty low number.
Compare that with 14.2% average annual return rate in private equity (Source: American Investment Council), the 60/40 returns seem silly.
How should you allocate your investment portfolio?
The real answer is that there is no set formula that works for everyone. Each investor needs to take into account different factors when it comes to asset allocation.
However, there are a few rules every investor should follow when it comes to portfolio allocation.
Diversify your portfolio: Never put all your eggs in one basket, especially when it comes to investing. While it’s pretty obvious you shouldn’t ever just invest in one stock, i.e., pouring every penny you have into only Tesla stock, the same goes for only betting on one type of investment. A healthy, diversified investment portfolio should include a variety of stocks including index funds and ETFs, bonds especially if you’re closer to retirement age, cash set aside for an emergency, and alternative assets, including real estate, cryptocurrency, illiquid items such as art and jewelry, and even private investments such as private equity and hedge funds, to mitigate risk within the stock market.
Assess your risk tolerance: Knowing your risk tolerance and allocating accordingly is essential for building a portfolio that works for you. If you are happy with lower returns that also come with lower risk, allocate accordingly. However, if you’re not risk-averse and have money you’re willing to set aside for investments that could generate a potentially high pay-off at a high risk, allocate accordingly.
Consider your age: If you are nearing retirement, then allocating more to less-risky investments such as bonds may make more sense for you, as you have less time to recover your finances. But if you’re a younger investor who can afford to take more risks and has more time to recover your portfolio should a risky investment go south, allocating to stocks, as well as alternatives such as cryptocurrency and private deals, may make more sense for you.
Overall, there is no one-size-fits-all strategy, including the 60/40 rule. Assess your investment goals, risk tolerance, age, and maintain a diversified portfolio with traditional and alternative assets, and you’re on track for building a portfolio that works best for you.