Vanguard Bullish on 60/40 Model for Long-Term Savers

The case for a 60/40 portfolio remains strong, with long-term investors in portfolios of 60% equity and 40% fixed income seeing a dramatic rise in the probability of achieving a nominal return of 7%, according to the Vanguard Group’s 2024 outlook, “A Return to Sound Money.”

The annual report by the asset manager suggested the increased likelihood of a 7% return was driven partly by rising interest rates boosting bond return expectations, a reversal from a decade of low rates. On the flip side, the elevated rate environment has led to lower asset valuations for equities globally, putting pressure on profit margins as corporations face increased costs for issuing and refinancing debt.

“Since last year, Vanguard has been pushing back against the view that the 60/40 way of investing is over or is dead,” said Roger Aliaga-Díaz, Vanguard’s chief Americas economist and global head of portfolio construction, during an investor webinar on Tuesday. “In fact, what we see from our capital market outlook: The future 60/40 is actually much brighter now than during the years of easy money, prior to COVID with zero rates.”

According to Aliaga-Díaz, a sense among investors that the 60/40 portfolios is no longer viable after recent stumbles—including a decline in both stocks and bonds—is overblown. He attributed that sentiment to investors experiencing volatility for the last two years extrapolating that event into the future and therefore challenging the 60/40 way of investing. But with the current level of higher return rates and equity valuations at “much more normal levels,” 60/40 may produce an average between 5% and 7%, in line with what the 60/40 has typically produced, according to Aliaga-Díaz.

For European investors, the 60/40 portfolio is currently showing a return of 4.5%, compared to 2% two years ago, said Jumana Saleheen, chief European economist and head of the European investment strategy group, in the webinar.

“That’s because markets have a much more solid foundation in the era of sound money, and interest rates are going to be sustainably higher,” she said. “With those overall higher returns, there’s also a smaller spread between the return from investing in a riskier portfolio versus a more defensive one. What I’m talking about, really, there is a narrowing of the equity risk spread. That means that there are lower rewards for taking risks in this current environment.”

60/40 in 2024

Aliaga-Díaz said the opinion that stocks and bonds no longer appropriately diversify each other is misguided; what really happened in recent years was that the interest rate was resetting at these higher levels, creating a transition from the era of venture capital money into the era of sound money, he told the audience.

“That transition was costly,” he said. “It did bring losses to both equities and bonds at the same time. Once in the new era of sound money … there is no reason to think that equities and bonds shouldn’t go back to the historical relationship of inverse or negative correlation.”

With central banks globally controlling inflation, more “typical” dynamics will emerge, Aliaga-Díaz said, with equity markets going down and regulators in the West able to “ease” interest rate policy.

“This will bring the rate down [and] help the bond side of the portfolio, and vice versa [with equities].”