What Falling Interest Rates May Mean for the 60/40 Portfolio

Key Takeaways

• In December 2023, the 60/40 portfolio bounced back after a pretty awful 2022. In 2024, the 60/40 portfolio is up about 10%.
• With the 60/40 portfolio, even though only 60% of your dollars are allocated to stocks, a lot of your risk is coming from the stock portfolio. So, directionally up or down is usually driven by stocks.
• During the recent stock market selloff, the 60/40 portfolio lost money because stocks are driving the direction. However, bonds finally provided the defensive ballast that they were known for before 2021 when this inflation wave began.
• Investors can expect the bond portion of the 60/40 portfolio to provide a cushion if we experience more volatility in the market this year.
• As the Federal Reserve may start to begin cutting interest rates rather than raising them, the bond portfolio should continue to be a good defensive component. However, inflation and recession risk can affect stocks.
• Given where we are in the economic cycle, where stock market valuations are, and where we could be headed, the 60/40 portfolio for a moderately risky investor is still a great place to be.

Susan Dziubinski: I’m Susan Dziubinski with Morningstar. A portfolio consisting of 60% stocks and 40% bonds is often considered a standard for investors with moderate risk tolerance because it provides exposure to the stock market with some downside protection from bonds. Here with me to take a temperature check on the performance of the 60/40 portfolio this year and to discuss what investors might expect from the portfolio ahead is Jason Kephart. Jason is director of multi-asset ratings for Morningstar.

Hi, Jason. Nice to see you.

Jason Kephart: Great to see you, Susan.

60/40 Portfolio Performance in 2024

Dziubinski: The last time you and I sat down to talk about the 60/40 portfolio was in December 2023, and back then, this blended portfolio had really bounced back after a pretty awful 2022. So, we’re in 2024, how do things look for the 60/40 this year?

Kephart: It looks good. It looks like a return to form. We’re sitting here in September the 60/40 portfolio is up about 10%. That’s kind of right in line with its 10-year average return, which is about 9.5% and that’s including 2022 where you had like a 17% drawdown. So, to kind of hit that 10-year average I think that should be within investors’ expectations. And the best thing is, stocks have a positive return, and for the first time in a while, bonds also have a positive return.

How Stocks Are Driving Returns of the 60/40 Portfolio

Dziubinski: Well, that’s what I wanted to get in with you a little bit is what really has driven that portfolio. Has it been largely the equities sleeve I would imagine?

Kephart: The 60/40 portfolio, even though only 60% of your dollars are allocated to stocks, really a lot of your risk is coming from the stock portfolio. So, directionally up or down is usually driven by stocks, and it’s been a good year for stocks so far. We have seen some extra volatility in the third quarter, but in general, it has been a very good year for the stock market.

The 60/40 Portfolio During the Recent Stock Market Selloff

Dziubinski: Let’s talk a little bit about the third quarter. Specifically in those first few days of August, we really experienced a pretty swift stock market selloff. And you did an article on Morningstar.com at that time that talked a little bit about the performance of the 60/40 during that selloff. How did it do?

Kephart: It lost money because as we talked about, stocks are really going to drive the direction. But what we saw that we haven’t seen in a long time, which was a beautiful thing, it was kind of like nature is healing, bonds finally provided that defensive ballast that they have been known for prior to 2021 when we had this inflation wave. That was really nice to see. I think that bonds could be counted on again when things are getting scary to actually get that flight to safety and help balance out your portfolio and lessen some of that volatility from the stock portfolio.

Can Bonds Protect the 60/40 Portfolio During Stock Market Volatility?

Dziubinski: Jason, given what we saw in early August with the 60/40 portfolio, do you think that investors can expect the bond portion of the 60/40 portfolio to provide that kind of cushion if we experience more volatility in the market this year?

Kephart: All signs we’re seeing point to yes. The biggest risk to your bond portfolio is going to be inflation. And higher-than-expected inflation is going to cause the Federal Reserve to raise rates, and that’s kind of what we’ve seen play out over the last few years. Obviously, a rising interest-rate environment could be very bad for your bond portfolio. But inflation seems to be chilling out. The Fed seems to be leaning toward more rate cuts in the future rather than rate hikes. I think worst-case scenario, you’ll probably see them keep rates the same. So, I think the trajectory of the bond portfolio is looking pretty attractive, especially from that defensive characteristic. All the hand-wringing we’ve done over the last few years about the bond portfolio, I think that’s over. I think we could rest easy on the bond portfolio for the foreseeable future and worry about the stock portfolio.

How Interest-Rate Cuts Could Affect the 60/40 Portfolio

Dziubinski: Everyone thinks we’re moving into an era where the Fed Reserve is going to begin cutting interest rates rather than raising them. Theoretically, what does that mean for the 60/40?

Kephart: I think it means the bond portfolio should continue to be a good defensive component. So, all the people saying you should diversify into things like liquid alternatives, private credits, stuff like that, that’s more complex, higher-fee, I don’t think you really need to do that to keep your portfolio well diversified. What it means for the stock market? We’ll see. I think a lot of the reasons for the inflation coming down and the Fed looking to cut, some recession fears are out there. Stocks are not going to do well in a recession. And you also have a lot of mega-cap stocks, everyone calls them the “Magnificent Seven,” trading at very high valuations. So, if there is a repricing, that can be painful for the 60/40, but I think in terms of the construct and the philosophy behind why you want to combine stocks and bonds, that’s very sound. I think that’s in a better spot than it’s been since 2021.

60/40 Portfolio Outlook

Dziubinski: And then lastly, Jason, given where we are in the economic cycle and given where stock market valuations are, the last time I checked Morningstar’s price to fair value, stocks looked about fairly valued to a smidge overvalued. Given that, what might we expect from the 60/40 portfolio over the next 12 months?

Kephart: I think we’ll see how the economic data looks and whether or not we can avoid a recession in the US. That’s obviously the biggest risk out there that we know about. So, I think that’s going to really come down to what the economic data looks like. But like I said, I think the 60/40 portfolio for a moderately risky investor is still a great place to be.

Dziubinski: Well, Jason, thanks for your perspective today. Good to talk to you.

Kephart: Thanks for having me.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch 3 Great Funds for the Class of 2024 for more from Jason Kephart.