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The Challenge of Diversifying with Bonds

As bond yields remain near historic lows, it may be time to rethink the 60/40 approach.

For years, the 60/40 portfolio—60% equities and 40% fixed income investments (typically U.S. bonds)—has been a cornerstone of investment thinking. The logic of the 60/40 portfolio makes sense: Diversification among different asset classes tends to reduce volatility. Historically, when stock prices fall, bond prices tend to rise.1 In addition, bonds have traditionally provided income for retirees and served as a hedge against inflation. But lately, the 60/40 asset allocation has started to fall out of favor among some financial professionals. As a result, investors may need to search for diversification elsewhere.

End of an Era?

The long-term track record of the 60/40 shows why it was such a bedrock part of investor thinking. From 1992 until 2019, a portfolio that was 60% invested in the S&P 500 and 40% in U.S. aggregate bonds delivered an average annual return of 8.5%, with volatility of 8.8%. Over that same period, the S&P 500 alone averaged slightly higher returns (9.8% a year), but with higher volatility of 14.4%. Bonds also provided a cushion during steep market drops, like during the dot-com bubble bursting in the early 2000s and the global financial crisis of 2008-2009, limiting the declines in a 60/40 portfolio when stock indices were plunging.2

What’s changed? The biggest shift has been the decline in bond returns. In the mid-2000s, before the financial crisis hit, yields on the benchmark 10-year Treasury were about 4.5%. (The overall return on a bond investment is a combination of yield and the price at which the asset is bought and sold, but in general, yields are a good indication of returns.2) That meant an investor could generate more than 4% returns with very little risk.

Interest rates have increased recently, but they remain quite low in historic terms. As of early April, 10-year Treasury yields were about 1.7%.3 (By comparison, yields on those were above 3% in 2018, and they haven’t been above 5% since 2007.) When you factor in current inflation—1.7% as of February 20214—that means that “real” returns, net of inflation, are zero. Investors are ending up with no additional spending power from what they put in.

U.S. 10 Year Treasury Note

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SOURCE: “U.S. 10 Year Treasury Note,”, April 5, 2021.

Bond Yields Could Continue to Rise

Strong economic growth prospects could push interest rates up. Economists currently estimate that economic output in the U.S. could rise by more than 5% in 2021. That kind of strong economic growth—due to the vaccine rollout, U.S. government stimulus spending, and a rebound effect following the economic lockdowns of 2020—could mean that the Fed would raise interest rates to head off inflation.5 If that were to happen, bond yields would rise as well, and investors with long-term bonds at lower yields in their portfolio could see the value of those investments decline sharply.6

At the same time, due to the pandemic, the correlation between stocks and bonds was at its highest level in the past two decades—meaning bonds aren’t offering true diversification.2

Pandemic Triggers Strongest Bond-Equity Correlations This Century
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SOURCE: Nikola Vasiljevic, “60/40 Portfolios: The End of the Road?”, Aug. 7, 2020.

For these reasons, bonds aren’t fulfilling their purpose of reducing risk in a typical 60-40 portfolio. Rather, they’re introducing risk in the form of low returns, limited diversification, and the potential for reduced valuations if rates rise.7

Other Sources of Diversification

None of this is meant to question the fundamental value of diversification. In fact, with major U.S. markets indices at or near record highs—and some metrics indicating that stocks may be overvalued—investors should consider all options to create a well-rounded portfolio.

That includes other asset categories like alternative investments.8 In particular, private-market investments may offer income to investors and diversification from the pricing sensitivity of bonds, considering today’s market conditions. This is because they tend to have a low correlation with publicly traded investments like stocks.

Critically, these other assets are not a straight swap for bonds—they’ll entail higher risk, and investors will need to determine whether they’re comfortable with higher risk levels. And bonds should still be in the consideration set for investors as well. But the traditional weighting of 40% in a portfolio, given current market conditions and yields, may no longer make sense.

1 Jared Woodard, “RIP 60/40 Portfolio,”, Nov. 2, 2020.
2 Nikola Vasiljevic, “60/40 Portfolios: The End of the Road?”, Aug. 7, 2020.
3 “U.S. 10 Year Treasury Note,”, April 5, 2021.
4 “Consumer Price Index Summary,” U.S. Bureau of Labor Statistics, March 10, 2021.
5 Matt Phillips, “Jittery Stocks, Jumpy Bonds: Why Investors Are Troubled by Signs of Growth,” New York Times, March 3, 2021.
6 Sunny Oh, “JP Morgan Joins the List of Wall Street Banks Calling for the Demise of 60/40 Portfolio, Despite Its Success This Year,”, July 4, 2020.
7 Russ Wiles, “The 60-40 Rule for Bonds and Stocks May Need Rethinking as Yields Fall,”, Oct. 27, 2020.
8 Paulina Likos, “Alternatives to the 60/40 Portfolio,”, Nov. 25, 2020.


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