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The 60/40 rule of Diversification

The 60/40 rule of Diversification

April 02, 2024

Investing 60/40 concept vs Growth/Income

Over my 20 years in this industry, I have heard and read many theories about how a person should invest as they approach retirement and into the long haul of their golden years.  Some of the more popular suggestions include:  50/30/20 diversification, 60/40 investing, or even CD or Bond ladders.  The fact is, for most nearing retirement, this is a difficult moment in time where the question of the next steps can be almost crippling. 

Financial Advisors may discuss many versions of diversification.  We have found  that there is no one answer that works for everyone.  This month, I’ll touch on the 60/40 model.  The 60/40 rule was initially developed by a Nobel Laureate Harry Markowitz in 1952 while finalizing his research on Modern Portfolio Theory (MPT).  His theory emphasized the importance of diversification and risk reduction by creating an efficient model that represents high possible returns for a given level of risk.  The 60/40 portfolio is a simple investment strategy that allocates 60% of your life savings to stocks and 40% to bonds.  This model has been referred to as a “balance portfolio.”  This percentage breakdown has been widely recognized and recommended by financial advisors and experts for decades.  The idea is that over the long haul, stocks have historically provided higher returns, while bonds offer fixed income and can act as a buffer during market downturns.  The science of this has and will continue to work.  Here is the question, how has it worked the last few years? 

Economics 101:  Interest rates affect Bond rates.  This will often be described  as a teeter-totter (do you remember these used to exist on the playground?).  This teeter-totter has interest rates on one side and bonds on the other.  When interest rates rise, bond rates go down.  Why not go to the other side of the “playground equipment” to rebalance your strategies?  In theory, this is a good idea.  However, since there have been 11 interest rates hikes since March 2022, we have come to rely on short term interest for growth.  This short-term malfunction to Markowitz’s theory has forced retirees to consider alternatives to income options in their own portfolios.  Additionally, both stocks and bonds plunged in 2022; high inflation, rising interest rates and concerns of a looming recession caused the S&P 500 to drop down 18%.  The Total Bond Index lost more than 13% also.  What does one do?

Let’s look at these questions: 

  1. What is your desired monthly income in retirement?
  2. After selecting Social Security and electing other guaranteed income sources, like defined benefit pensions, what is your gap to your retirement income need?
  3. There are many strategies to resolve this shortage, have you explored all the options?
  4. Considering this gap, how much risk to a guaranteed paycheck do you really want to take?

    There is a lot to learn and consider in the 10 years surrounding your final “punch-out” at work.  Make sure a trusted Financial Advisor is keyed up before you “clock out” on your last day. Give us a call! We can help!

     Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer. Guarantees provided are based on the claims paying ability of the issuing company. Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends. The Standard & Poor's 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock's weight in the index proportionate to its market value. 2) If the reference to “guaranteed income” refers to fixed annuities, please add the FA Disclosure or let me know what is being promoted here. If you add the FA Disclosure, you do not need the above Guarantee Disclosure: Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the first 5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.