The 60/40 is Dead. Long Live the 60/20/20

The ‘60/40’ has long been the standard-bearer when it comes to recommended portfolio allocations. The strategy involves allocating 60% of an investment portfolio to stocks and 40% to bonds, with the theory being that the bond allocation will act as a hedge against stock market volatility (should stocks lose value, bonds will increase in value–as the two asset classes are typically inversely correlated).

Yet that inverse correlation isn’t set in stone. In fact, over recent years, stocks and bonds have grown positively correlated, much to the chagrin of 60/40 investors.

2022 is a perfect example. The S&P 500 plummeted 19%. The NASDAQ fared even worse, with a massive 33% drop. Despite the volatility in the stock market, U.S. bonds experienced their worst year ever. Intermediate-term Treasury bonds lost 10.6% for the year, and long-dated (30-year) Treasury bonds plunged 39%–the most since 1754!^[1]

As a result of the volatility in both the stock and bond markets, the 60/40 portfolio suffered its worst performance since 2008. This left many investors wondering if the 60/40 portfolio is dead, and if so, what should take its place?

In this article, we’ll explore the perceived benefits of the 60/40, and how those benefits improve with the introduction of alternative investments. We’ll also examine some new allocation ratios that are taking the place of the 60/40, and explain how accredited investors can begin allocating to alternative investments today.

Adding Alternatives into the Mix

The 60/40 portfolio is a classic asset allocation strategy that aims to balance risk and return for investors with a moderate risk tolerance.

The purpose of the 60/40 is to provide investors with diversification by combining the growth potential of stocks (60%) with the stability and income flow of bonds (40%). In other words, the 60/40 seeks to achieve a balance between the higher potential returns of equities and the lower risk of fixed income.

Historically, the 60/40 portfolio has delivered stronger returns with lower volatility than an all-equity portfolio over the long term. This is due to the fact that the bond allocation acts as a buffer during equity market downturns, providing diversification benefits. The 60/40 is also a simple, easy-to-understand strategy which makes it suitable for individual investors.

Yet the correlation between stocks and bonds has shifted. With a positive correlation between the two, 60/40 investors lose the diversification benefits that are so crucial to the portfolio’s performance. As a result, many institutional investors are recommending that their clients incorporate alternative investments to enhance diversification and potentially improve returns.^[2] A 2024 survey by Nuveen found that 55% of institutional investors planned to increase private asset and alternative investment allocations over the year (41% plan to increase allocations to private credit).^[3]

Given that institutional players are piling into alternative investments, it's worth exploring how individual investors can allocate alternative investments into their portfolios as well.

Alternatives to the 60/40

1. 60/20/20 Portfolio

This strategy involves reducing the bond allocation and incorporating alternative investments into the portfolio mix.

Specific allocations are as follows:

60% to stocks
20% to bonds
20% to a mix of alternative investments

The theory behind the 60/20/20 is that investors should transfer half of their bond portfolio over to alternative investments. Similar to bonds, some alternatives provide monthly cash flows (real estate, private credit), and investors obtain the added benefit of portfolio diversification into assets that are uncorrelated with public equities.

2. 40/30/30 Portfolio

This strategy involves a more balanced approach by allocating:

40% to stocks
30% to bonds
30% to alternative investments

This approach aims to improve the portfolio's risk-adjusted returns by transferring a portion of the stock allocation to alternatives as well. The 40/30/30 approach gives investors a slight overexposure to stocks, which reduces overall portfolio volatility.

3. Endowment Model

Pioneered by David Swensen at Yale University, this model emphasizes a strong equity focus and significant allocations to alternative investments, with minimal exposure to U.S. government bonds.

Under Swensen, the Yale Endowment did not invest in corporate bonds because of their inherent principal-agent conflict — company management has to drive value for both stock- and bondholders — and because they display a minimal premium relative to government bonds after factoring in defaults. Swensen also avoided non-US bonds because, despite potentially similar/offsetting returns, the associated currency risk and uncertain performance in volatile times did not align with his long-term investment goals.

During his 25 years managing the Yale Endowment, Swensen achieved a 12.5% annualized return and outperformed the S&P 500 by 280 basis points (bps).^[4]

How to Start Allocating to Alternative Investments

According to research by JPMorgan Asset Management, three common portfolio compositions—the default 60/40, the more defensive 40/60, and the more aggressive 80/20 allocations—all underperformed or realized inferior risk-adjusted returns relative to portfolios that decreased their stock or bond allocations in favor of infusing alternative investments.^[5]

With that in mind, many investors are eager to begin allocating a percentage of their portfolio to alternatives. The question then becomes: how best to go about that?

Until recently, it would have been extremely difficult for individual investors to allocate investments into any alternatives apart from real estate and precious metals. However today, a plethora of digital platforms exist that support investments into private equity, private credit, startup companies, art, collectibles and more.

Heron Finance is one such platform–in fact, we’re the first-ever robo advisor exclusively focused on private credit. Our platform builds diversified portfolios of private credit deals for accredited investors.

If you’re an accredited investor and would like to start investing in alternative assets like private credit, click the link below to set up your Heron Finance account today.