Asset allocation

The improved outlook for the 60/40 portfolio

March 06, 2023

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

Painful year improves long-term expected results

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
A stacked bar chart with three sections shows valuation percentile relative to fair value. The sections are labeled stretched value, fairly valued, and undervalued. Overlaying dots and arrows show valuations for each broad asset class as of year-end 2021 versus year-end 2022. U.S. stocks went from the 98th percentile as of year-end 2021 to the 79th percentile as of year-end 2022, remaining in the stretched range. Non-U.S. stocks went from the 49th percentile to the 44th percentile, remaining in the fairly valued range. U.S. bonds fell from the 55th percentile to the 43rd percentile, also remaining fairly valued, as did non-U.S. bonds, which went from the 60th percentile to the 37th percentile. Although none of the asset classes dropped to the undervalued category, all saw significant decreases in valuation.

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
Two box-and-whiskers charts show the range of expected annualized returns over 10 years for the global 60/40 portfolio as of year-end 2021 versus year-end 2022. For 2021, the 5th percentile outcome is a 0.38% return, the 25th percentile is 2.41%, the median or 50th percentile is 3.83%, the 75th percentile is 5.23%, and the 95th percentile is 7.36%. For year-end 2022, the 5th percentile outcome is a 2.59% return, the 25th percentile is 4.60%, the median or 50th percentile is 6.09%, the 75th percentile is 7.61%, and the 95th percentile is 9.84%. An accompanying table shows additional risk metrics. The expected annualized median volatility or standard deviation is 9.51% at year-end 2021 versus 9.86% at year-end 2022. The expected maximum drawdown in any given year is minus 46.73% at year-end 2021 versus minus 40.97% at year-end 2022. The probability of a 10% loss in any given year is 59.50% at year-end 2021 versus 39.49% at year-end 2022.

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.”

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.

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.

2 Based on the range of projected 10-year outcomes as calculated on December 31, 2012, by our Vanguard Capital Markets Model (VCMM).

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Notes:

All investing is subject to risk, including possible loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss. Past performance is no guarantee of future returns.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

IMPORTANT: The projections and 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. VCMM results will vary with each use and over time.

The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

Contributors

Todd Schlanger
Todd Schlanger
Ziqi Tan

Ziqi Tan

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