A look back and forward at the 60/40 portfolio

Commentary by By Todd Schlanger, senior investment strategist, Vanguard.

• Traditional 60/40 portfolios enjoyed a strong decade up to and including 2022.
• The long-term return outlook for equity and bond markets has improved significantly, owing to the steep declines in 2022.
  
• Vanguard’s forecasting model suggests 60/40 portfolios are poised for another strong decade.
  

The 60% stock/40% bond portfolio declined 9% in 2022 - a painful period for multi-asset investors that has raised doubts about the viability of the strategy. But it helps to put this in perspective: The annualised return for the 10 years to the end of 2022 was 6.9% for a globally diversified 60/40 portfolio¹. 

If you look at the nine years prior to 2022, a globally diversified portfolio posted a lofty 8.9% annualised return, despite the low interest rate environment. That put 60/40 returns on track to be within the top 12% (88th percentile) of projected outcomes when we run our 10-year annualised return forecasts as of 2012. Even after taking 2022 into account, the 10-year return fell within the top third (69th percentile) of projected outcomes². 

The silver lining to market falls

While 2022 may have been painful for investors, the result was that valuations for asset classes are now lower, and most are attractive. The notable exception are US stocks, which are more reasonably priced now but still above what we consider to be the fair-value range.

With these more favourable valuations, Vanguard’s modelling shows that the long-term return outlook for the 60/40 portfolio has notably improved.

The chart below shows the range of expected annualised returns over the next 10 years for a global 60/40 portfolio as of year-end 2022 relative to 2021. Expected returns have improved, with less downside risk.

Expected 10-year annualised returns        

Source: Vanguard calculations in GBP, as at 31 December 2021 and 31 December 2022. Notes: The forecast corresponds to the distribution of 10,000 Vanguard Capital Markets Model (VCMM) simulations for 10-year annualised nominal returns in GBP for the 60% equity/40% bond portfolio. Median volatility is the 50th percentile of the distribution of annualised standard deviation of returns. Portfolio returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect the reinvestment of income and capital gains. Indices are unmanaged; therefore, direct investment is not possible. Equity comprises UK equity (MSCI UK Total Return Index) and global equity (MSCI AC World ex UK Total Return Index). Fixed income comprises UK bonds (Bloomberg Sterling Aggregate Bond Index) and hedged, global bonds (Bloomberg Global Aggregate ex Sterling Bond Index Sterling Hedged). UK equity home bias: 25%, UK fixed income home bias: 35%.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations are as at 31 December 2021 and 31 December 2022. Results from the model may vary with each use and over time.

Our models suggest sterling 60/40 investors can reasonably expect anywhere between 4.3% and 7.9% each year over the next decade. That’s up from our 2021 year-end expectations of between 1.8% to 5.3%. 

There is a lot of noise in the short term, including the swathe of one-year market projections that often hog the headlines, but we tend to focus on the medium to long term with our forecasts – and with good reason.

While equities tend to gain much of the attention, more of the improvement in our projections stem from fixed income, with expected returns more than twice as high than they were going into 2022. Far from being dead, we think the 60/40 portfolio is poised for another strong decade.

¹ Vanguard calculations in GBP, based on data from Refinitiv. Calendar-year 2022 returns from 31 December 2021 to 31 December 2022 were -9.0% for the 60% equity/40% bond portfolio. Equity comprises UK equity (MSCI UK Total Return Index) and global ex-UK equity (MSCI AC World ex UK Total Return Index). Fixed income comprises UK bonds (Bloomberg Sterling Aggregate Bond Index) and hedged, global ex-UK bonds (Bloomberg Global Aggregate ex Sterling Bond Index Sterling Hedged). UK equity home bias: 25%, UK fixed income home bias: 35%. 10-year annulised returns of 6.9% based on data between 31 December 2012 and 31 December 2022.

² Based on the range of projected 10-year outcomes as calculated on 31 December 2012, by our Vanguard Capital Markets Model (VCMM). Nine-year annualised returns of 8.9% based on data between 31 December 2012 and 31 December 2021.