The 60/40 portfolio model has been a mainstay of the investment world for decades, and for most of that time it has served investors very well. It calls for 60% of a portfolio to be allocated to equities to drive growth, and the remainder to be devoted to bonds to provide stability when financial markets encounter turbulence. Prices for bonds tend to be far more stable than those for equities, and bonds are also a useful source of income.
The model works well because equities and bonds tend to move in opposite directions: when equity prices rise, bond prices tend to fall, and vice versa. This means that, over time, the 60/40 portfolio should prove far less volatile than one devoted exclusively to either bonds or equities.
There have, of course, been times when that inverse correlation has broken down. No investment strategy is ever perfect. 2022 provides an example, with prices for bonds and equities falling in tandem. Prior to 2022, however, there were only two calendar years in which both stocks and bonds declined: 1931 and 1969.
The 60/40 model illustrates the vital role bonds can play in any portfolio. However, the ratio between equities and bonds can be varied to meet the differing risk appetites of investors. Increasing the allocation to bonds can make a portfolio more suitable for the most cautious investors, while dialling down exposure to fixed income can allow a portfolio to meet the needs of investors with higher risk appetites.
A portfolio aimed at low-risk investors would likely have an allocation of between 15% and 40% to equities, with the remainder composed of bonds. A suitable ratio for medium-risk investors could be up to 60% in equities and the balance in bonds. Finally, a high-risk appetite could be served by allocating 70% upwards to equities.
The mixture of bonds in the portfolio can also be varied to suit varying risk appetites. Bonds issued by governments of advanced economies tend to be regarded as among the safest investment instruments in the world. Indeed, these bonds are considered safe havens and in times of geopolitical or financial turbulence their prices tend to shoot up due to investor demand.
Corporate bonds come below government bonds in the safety pecking order, but there is a large range within the corporate bond sector. Bonds issued by very large companies that have been around for decades, and which have a strong range of brands that benefit from steady demand, are highly valued in terms of safety. These bonds fall into the category known as investment grade.
Finally, there are high-yield bonds: those issued by startup companies, capital-intensive firms with high debt ratios, or businesses that have fallen on hard times and are trying to mount a recovery. These are riskier than investment-grade bonds, and investors are compensated for this risk with higher yields.
Depending on the risk appetite of an individual investor, it is possible to build a portfolio composed of a variety of asset classes, including an allocation of bonds – comprising a mix of government and corporate bonds – that matches their appetite.
Disclaimer: Australian Bond Exchange Pty Ltd ACN 605 038 935 AFSL 484453 (ABE). This article is intended to provide general information of an educational nature only. It does not constitute the provision of personal advice and does not take into account your personal objectives, financial situation or needs. Before investing with ABE, you should consider the appropriateness of the investment to your particular financial and taxation situation and consider obtaining independent advice before making an investment. Examples in this article are for illustration purposes only and are not a recommendation to buy, sell or hold a particular investment. ABE makes no representation or guarantee as to the availability of a bond with the characteristics described in this article or that an investment made by you will generate the returns in the illustration. Past performance is not an indication of future performance. Investing with ABE is subject to our Client Services and Custody Agreement Terms and Conditions and Financial Services Guide.