An old investing rule of thumb is working better than it has in a while.
It’s called the “60-40” rule — which describes a portfolio made up of 60 percent stocks and 40 percent fixed-income securities. Advisors have recommended the balance as a middle-of-the-road way of investing. It puts the majority of an investor’s money into stocks, which are riskier but higher yielding than bonds, while still having a solid amount held in government, corporate and agency bonds.
The Vanguard Balanced Index fund, which mirrors that portfolio rule, just had its best quarter in nearly a decade with a 9.5 percent gain in the first quarter.
The approach is usually more of a hedge. When stocks do well, it’s not typically the case that bond prices also rally. But this year has been different, thanks to the Federal Reserve.
The Fed signaled in January that it was putting the brakes on raising its short-term benchmark rates. Investors embraced the stance and bought bonds, pushing their prices higher as the yields fell. That also boosted stocks. Higher rates can sometimes dampen enthusiasm for stocks because rising borrowing costs eat into corporate profits and can make earnings valuation look too high.
Bond yields and prices move in opposite directions. In this case, lower yields means higher bond prices, and therefore more value for that 40 percent of an average investors’ “60-40” portfolio. With the Fed no longer a roadblock, and the economy chugging along at a respectable 2 percent growth, U.S. stocks and bonds have both been in favor this year.
In other words, the quarter was “the perfect storm, in a good way” for investors, according to Paul Schatz, president at Heritage Capital.
“The rising tide of the first quarter has lifted all ships, debris and just about anything and everything in the ocean,” Schatz said. “The 60-40 portfolio was an easy winner.”
The other factor boosting U.S. Treasurys was how good they looked compared to the rest of the world. The German and Japanese 10-year government bonds, for instance, both yield negative interest rates. Any return looks great in comparison, especially for global investors looking for a place to park their money. The U.S. 10-year yields just under 2.5 percent.
“We might think of U.S. bonds as low income — but for the rest of the world it’s like a high yield bond,” said Ken Kamen, president of Mercadien Asset Management. “Worldwide demand is helping.”
The amount a retail investor should put in stocks versus bonds has a lot to do with their tolerance for risk and how close they are to retiring. Advisors often recommend that younger investors invest a greater portion of their money in stocks, or around 80 percent. Someone who is retired, on the other hand, might put 30 percent in stocks and have 70 percent in bonds.
Another rule of thumb advisors have used over the years is to subtract their age from 100. The remainder is the percentage of their portfolio that should be in stocks, some advisors say.
“It is the default for people, it has worked for the past 30 years and it continues to work,” said Rick Ferri, investment advisor and author of “All About Asset Allocation”. “It’s a pretty nice long-term allocation that outperforms most endowment funds for years, and is a tough balance to beat.”
Ric Edelman, CEO of Edelman Financial Services, said the fact that the 60-40 model worked so well is more of a reflection of the strong quarter than anything. The start to 2019 was a “a wonderful environment” for both stocks and bonds, he said. But that might not last.
“Sixty-forty has never not worked,” said Edelman. “But it’s unrealistic that the pace continues. We need to temper our enthusiasm.”
Based on the first-quarter’s double-digit rally, if the S&P 500 stayed on the same growth trajectory, it would end the year up by more than 40 percent. Edelman expects that growth in share prices to retract, or slow at the very least.
Others are less excited about the old-school model, regardless of how great the quarter was. As money manager Peter Tanous put it — the 60-40 model is “dead.” Tanous, who has been in the business for 50 years, said there was a time when it worked great because bonds would kick back 8 percent.
“The problem is, that has not been true for a number of years,” Tanous told CNBC. In the prolonged low-rate environment over the last decade, “the 40 percent in bonds is sitting there ‘doing nothing.'”
“You need to look for other creative ways to create income, and you may need to take a little more risk compared to the old days,” he said.
— With reporting by Michael Santoli