Over the last two decades, it was a rule of thumb for almost all financial advisors: Investors should put 60% of their investment in stocks and 40% in bonds. The balance was presumed to be the “perfect” shield against falling stock prices while benefiting from potential growth.
For a while now, the narrative has been sold by market players such as financial advisors, banks, traders, and analysts.
Savings and retirement funds have also been religious followers of the 60-40 rule.
But with the changing market dynamics, advisors are starting to rethink this strategy with some calling it a ‘split dead’.
Last year, a Bank of America report by Jared Woodard and Derek Harris fired the first shot, arguing that bonds were no longer the “ultimate” diversification tool. In the report, the duo noted that in the long term, bonds were bound to be more volatile. The 60-40 split strategy was more viable in a market where stocks and bonds had a negative correlation, they argued.
Bond yields were known to rise as stock prices fall, qualifying bonds as the ideal hedges against falling stocks. Stocks cushioned investors against inflation.
A section of the report read: “But this assumption was only true over the past two decades and was mostly false over the prior 65 years. The big risk is that the correlation could flip, and now the longest period of negative correlation in history is coming to an end as policymakers jolt markets with attempts to boost growth.”
Woodard and Harris recommend diversifying into other assets such as riskier bonds and high-dividend stocks. Junk bonds (high yield) and municipal and short-term debt are great substitutes to conventional bonds.
Economists from the Bank of America predict a volatile bond market in the years to come, coupled with regular recessions. However, bonds are known to be less volatile in down markets compared to high-yielding bonds and stocks.
So while real estate and high-yielding bonds tend to offer higher returns, they are historically riskier. And stocks record even more significant dips during recessions.