75/25 Is the New 60/40
For decades, the 60/40 portfolio allocation was regarded as the standard in generating the optimal risk/reward balance.
- In 2020, Wharton Business School’s Professor of Finance, Jeremy Siegel, believes the allocation of 75% stocks and 25% bonds is the new way to go.
A look into the past 📖
The 60/40 split has been the standard for portfolio allocation for decades. This allocation gives investors a good diversification of riskier but higher return stocks and safer but lower return bonds. This rule worked for several decades in market conditions of decreasing interest rates that favored both stocks and bonds. Near the end of 2019, investment banks including Bank of America and Morgan Stanley sounded the alarms to an upcoming period of low returns for bonds and the death of the 60/40 portfolio.
A look into the future 🔮
Jeremy Siegel warns investors to expect lower returns for both stocks and bonds in the next century. His recommendation is to change from a 60% stocks and 40% bonds portfolio allocation to 75% stocks and 25% bonds. This belief is driven by several market conditions:
- Stocks are expected to have lower returns… investors will need to increase their stock holdings to make up for the lower return.
- Bond prices rise when interest rates drop… but with interest rates already at zero, there really isn’t room to go any lower.
With all the information presented, lower bond returns does not necessarily mean investors should allocate their whole portfolio to stocks. Diversification is important and reserving an allocation for bonds will balance out the risks in a portfolio.
Remember that the correct portfolio allocation is different for everyone. Those that have a longer investment period and higher tolerance for risk can afford to allocate a higher portion to stocks.