The outlook for the 60/40 portfolio
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For the traditional 60/40 portfolio, 2022 was a punishing year. But the old standby’s long-term record has been stellar and, with current valuations, expected returns for the next decade have improved.
The 60/40 portfolio had an outstanding decade—even counting 2022
The typical 60% stock/40% bond portfolio declined about 16% in 2022—a painful period for balanced investors that has raised doubts about the viability of this strategy. But it helps to put this in perspective: The annualized return for the 10 years through 2022 was 6.1% for a globally diversified 60/40 portfolio.1
“The past decade has been a strong run for the 60/40,” said Todd Schlanger, a senior investment strategist at Vanguard. “If you look at the nine years prior to 2022, a globally diversified portfolio posted a lofty 8.9% annualized return, despite the low interest rate environment. It was on track for a 92nd percentile outcome based on our projections. Even after taking 2022 into account, the 10-year return beat expectations at the 63rd percentile.” 2
Valuations fell in 2022, improving long-term expected returns
It also helps to consider what the losses investors experienced in 2022 could mean for the next decade, Schlanger said: “While 2022 may have been painful for investors, the result was that valuations for asset classes are now lower, and most are fairly valued. The notable exception: U.S. stocks, which are more reasonably priced now but still above what we consider to be the fair-value range.”
The first figure looks at Vanguard’s valuations for broad asset classes as of year-end 2022 versus year-end 2021.
Valuations fell in 2022
Notes: The U.S. stock valuation measure is the current cyclically adjusted price/earnings ratio (CAPE) percentile relative to fair-value CAPE for the S&P Composite Index from 1940 to 1957 and the S&P 500 Index from 1957 through December 31, 2022. The non-U.S. stock measure is a blend of 70% developed markets and 30% emerging markets using MSCI indexes. Developed-market stock valuation measures are the current CAPE percentile relative to the fair-value CAPE. The non-U.S. developed markets valuation measure is the market-weighted average of each region’s (Australia, U.K., euro area, Japan, and Canada) valuation percentile. The emerging markets measure is the percentile rank based on our fair-value model relative to the market. The U.S. bond valuation is the weighted average between intermediate-term credit and U.S. Treasury valuation percentiles using Bloomberg indexes. The non-U.S. bond valuation measure is the market-weighted average of each region’s (Australia, U.K., euro area, Japan, and Canada) valuation percentile.
Sources: Vanguard calculations, based on data from Robert Shiller’s website (aida.wss.yale.edu/~shiller/data.htm), the U.S. Bureau of Labor Statistics, the Federal Reserve Board, and Refinitiv, as of December 31, 2022, and December 31, 2021.
“With these more favorable valuations, Vanguard’s modeling shows that the return outlook and the worst-case risk scenario for the 60/40 portfolio have notably improved,” said Ziqi Tan, a Vanguard investment strategist.
The next figure shows the range of expected annualized returns over the next 10 years for a global 60/40 portfolio as of year-end 2022 versus 2021. Expected returns have improved, with less downside risk.
10-year outlook for the global 60/40 portfolio has improved
Notes: The chart shows the range of expected annualized 10-year returns for the hypothetical global 60/40 portfolio as of year-end 2022 versus year-end 2021. The table shows risk metrics. Please see footnote 1 for the indexes and weightings used for the portfolio.
Source: Vanguard Capital Markets Model projections.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model 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 the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of December 31, 2021, and December 31, 2022. Results from the model may vary with each use and over time. For more information, please see the Notes section below.
“There is a lot of noise in the short term, so we tend to focus on the medium- to long-term with our forecasts,” Tan said.
There’s another factor in favor of a better outcome, according to Schlanger: “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 two times higher than they were going into 2022. Far from being dead, the 60/40 portfolio is poised for another strong decade.”
1 Vanguard calculations, based on data from Standard & Poor’s, MSCI, and Bloomberg. Returns in 2022 were –16.1% for the U.S.-only 60/40 portfolio and –15.7% for the globally diversified 60/40 portfolio. For the U.S. portfolio, we used the S&P 500 Index as a proxy for stocks and the Bloomberg U.S. Aggregate Bond Index as a proxy for bonds. For the globally diversified 60/40 portfolio, we used the following proxies: for U.S. stocks, a 36% weighting in the MSCI US Broad Market Index; for non-U.S. stocks, a 24% weighting in the MSCI All Country World ex USA Index; for U.S. bonds, a 28% weighting in the Bloomberg U.S. Aggregate Bond Index; and for non-U.S. bonds, a 12% weighting in the Bloomberg Global Aggregate ex-USD Index. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
2 Based on the range of projected 10-year outcomes as calculated on December 31, 2012, by our Vanguard Capital Markets Model (VCMM).