It’s Time to Rethink the 60/40 Portfolio

As investors increasingly face diminishing returns and higher risk, there is a resounding desire to diversify their portfolios outside of stocks and bonds.  If you are one of those investors, we’d guess that to earn better returns, you are willing to take on some risk—but with the caveat that you don’t take on too much.  It may feel like a fine line to walk, but it is possible with the correct asset allocation.  This is a decision that, like many things in life, depends on several factors:

  • Are you comfortable with higher risk for higher returns?  
  • Do you value the ability to buy and sell assets quickly?   
  • Are you seeking the ultimate safety of bonds, CDs, annuities, or cash in the bank?  
  • How long until you need to access your investments for retirement spending? 

The answers here will result in different levels of acceptable risk and expected returns.  Picking asset allocations in a portfolio is an individual choice, one that requires some introspection: how much risk you are willing to take and how much loss you can tolerate without losing sleep?

The 60/40 Portfolio

Old-school investing advice has gone something like this: focus more heavily on stocks when you are young and slowly increase your bond holdings as you approach retirement, ultimately reaching 60% in stocks and 40% in bonds.  The notion behind this advice is to grow your capital through stocks but dampen volatility with stable, income-generating bonds at retirement.  

Today, that traditional 60/40 portfolio no longer produces the safe returns and diversification it once did.  Why?  Because interest rates are so low.  For a typical retirement-age investor, that 40% they locked up in bonds is now effectively producing a negative yield (the interest rate earned after factoring for inflation).  The stable income-generating bond simply doesn’t exist right now.

If you are holding a low-yielding bond today and interest rates start going up tomorrow, that bond will lose principal.   And since interest rates are already rock bottom, there’s no room for your bond to go up in value from interest rates decreasing.  Therefore, your risk is much higher than you probably think, and it is all skewed to the negative side.  

The stock market can feel just as chaotic.  The S&P 500 is reaching valuations (measured by the price-to-earnings ratio) that have only been exceeded two other times:  the market crash in 2001 and the 2008 financial crisis.  Is there potential for equities to continue to increase?  Sure, but there’s the potential that equities could retreat to more typical valuations and lose value as well.  So, if the two biggest segments of most investment portfolios seem risky, what do you do?

Real estate is a natural bridge between stocks and bonds. 

The solution is to seek out investments that offer bond-like dividends and stock-like equity appreciation.  Private real estate is taking a bigger place in investment portfolios due to its central position in both risk level and expected return, low correlation to stocks and bonds, and inflation resistance.  Not to mention, it’s a real asset, with tangible value.

Rent pays dividends; rising rents and land value produce equity appreciation.  Together, these income streams produce yields that sit comfortably between bonds and stocks—without excess risk.  Private real estate also tends to be less correlated with movements in stock and bond prices, and it is a solid hedge against inflation.  As such, it is a key to unlocking a properly balanced portfolio.   

Pick an asset allocation that produces enough expected returns to meet your objectives.  Then make sure it doesn’t incur too much risk.  If you can withstand losing 40% of your portfolio value, you may be happiest with an equity-centric portfolio.  If you desire safety, you may want to hold more cash.  The important thing is knowing the chance your investments have at losing value and determining whether you can accept that (and sleep soundly at night).

Download this template to help guide you in determining how to allocate your real estate portfolio.  This template contains inputs such as total investable assets, allocation, need for liquidity, and risk tolerance to help you decide how much and where to allocate your real estate investments.  

(Note that this template is only an illustration of potential real estate allocation decisions. You should consult with your professional advisors who can help you understand and assess the risk of any investment opportunity.)

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