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This Popular Portfolio Strategy Can Actually Make You Lose Money


Many long-term investors have championed the 60/40 portfolio, which holds 60% in stocks and 40% in bonds, as a classic investment strategy that can deliver risk-adjusted returns. But Morningstar says that persistent inflation and interest rate increases in 2022 have caused investors using this asset allocation mix to lose more money than if they had invested broadly in stocks. Let’s break down why the 60/40 portfolio is reaching historic lows and what investors can do to protect their money.

A financial advisor can walk you through different asset allocation strategies to adjust your portfolio for inflation and rising interest rates.

Why the 60/40 Portfolio Is Reaching Historic Lows

The 60/40 portfolio was designed to help investors minimize risk and generate a consistent rate of return over time. This is done by building a portfolio that allocates 60% to stocks and 40% to bonds. In doing so, investors take on more risk to profit from the higher growth potential of stocks and counterbalance that risk with safer investments in bonds.

The basic idea behind this asset allocation mix is this: While stock and bond markets can go down from time to time, they rarely go down together. But in 2022, the Chicago-based financial firm Morningstar says that this portfolio strategy has been tipped off balance by persistent inflation and the Federal Reserve’s interest rate hikes.

“The result is that even investors with portfolios diversified among stocks and bonds — through what is often referred to on Wall Street as the 60/40 portfolio approach — are facing losses approaching 20% this year. In fact, in the third quarter, the performance of a 60/40 portfolio would have been worse than one just invested broadly in stocks,” Morningstar published in an article.

According to the financial firm, stocks hit a new bear market low with the asset’s worst performance in 2022 so far — down 24.9%. And bonds, concurrently, are also “having their worst year in modern history,” falling 14.6% during the same time period.

In the past, a low correlation between stocks and bonds offered investors an attractive way to diversify portfolios and benefit from the returns of both asset classes. However, persistent inflation and the Federal Reserve’s response to raise interest rates have led to a higher correlation between both investments. And this is causing many Americans to lose record money.

Why Stocks and Bonds Are Slumping

SmartAsset: Can the 60/40 Portfolio Still Protect Your Investments?

Stocks and inflation can have a low correlation, with stock prices going down as inflation goes up. And in 2022, the Morningstar U.S. Market Index has fallen for three consecutive quarters, with “losses not seen since 2008.”

Inflation can affect stock prices in three ways:

  • Companies have lower profit margins as raw materials, labor and overhead costs increase.
  • Consumers don’t have as much money to buy company goods and services, therefore decreasing corporate revenue and net income.
  • And, when a central bank raises interest rates to control inflation, companies shy away from borrowing money because it costs more to take on additional debt.

Now, with the highest inflation rate in four decades, the Federal Reserve has raised interest rates three times on May 5, June 15 and July 27. And this too has caused bond prices to drop.

Bonds tend to move in an opposite direction from interest rates. So as the Federal Reserve raised interest rates in 2022, many investors who were already seeing stocks drop in a bear market could not find safe harbor in their bond investments either.

In the past, investors using the 60/40 asset allocation mix relied on more conservative bond investments for diversification. But with persistent levels of inflation this year, the relationship between stocks and bonds could continue to invert as the Federal Reserve raises interest rates.

“I believe the stance of monetary policy is slightly restrictive, and we are starting to see some adjustment to excess demand in interest-sensitive sectors like housing. But more needs to be done to bring inflation down meaningfully and persistently,” Federal Reserve Governor Christopher Waller said in a speech. “I anticipate additional rate hikes into early next year, and I will be watching the data carefully to decide the appropriate pace of tightening as we continue to move into more restrictive territory.”

How Investors Can Protect Their Portfolios

With persistent inflation and interest rate hikes on the horizon, investors may want to adjust their investment style and consider other asset allocations to balance their portfolios.

Here are four common investment strategies:

  • Look beyond value and growth. Investors often compare value stocks with growth stocks when building a portfolio. But during a volatile market, it can be difficult to pick between either. Morningstar, however, says investors can identify other investment opportunities instead by calculating the beta or volatility of a stock.
  • Add other hedges against inflation. Some investors believe that stocks are still reliable hedges because they can historically produce total returns that exceed inflation. Others will hold on to their savings bonds because they guarantee how much you will get paid. But you can also consider adding real estate and commodities as inflation hedges to diversify your portfolio.
  • Combine both active and passive investments. Investors are often divided between picking active funds that aim to beat a stock market or passive funds that only track it. Though you can also take a middle-ground approach and research whether combining both active and passive investments can help your portfolio adjust to the changing market and also capitalize over time.
  • Minimize your losses with tax-efficient strategies. Investors can help boost their portfolios by using their investment losses to lower capital gains taxes. This strategy is called tax-loss harvesting and here are two examples to compare how much you can save.

Bottom Line

SmartAsset: Can the 60/40 Portfolio Still Protect Your Investments?

Both rising inflation and interest rate hikes have changed the relationship between stocks and bonds in 2022. And while the 60/40 portfolio may still be a preference for some investors, others look into different investment styles and asset allocations to diversify their portfolios.

Tips for Investors During Inflation

  • financial advisor can help you compare different asset allocation strategies for your investment portfolio needs. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you want to know how much your investments can grow over time, SmartAsset’s free investment calculator can help you get an estimate.

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