If you’ve ever spoken to a financial adviser or read an investment magazine, you’ve probably come across the term “60/40 portfolio” before. But what exactly is a 60/40 portfolio, and why have they proved so popular over the years?
The term “60/40” refers to a style of asset allocation. Asset allocation is simply the process of splitting any money you plan to invest between different types of assets. The goal of asset allocation is to deliver the best possible expected return for your money, while avoiding taking more risk than you feel comfortable with.
In the case of a 60/40 portfolio, 60% of your money goes into riskier assets – typically shares (or equities as they’re sometimes called). The other 40% goes into less risky assets – typically government bonds, which are just IOUs issued by governments.
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Please note that when we talk about risk in this context, we’re referring to the longer-term volatility of your portfolio, rather than the risk of losing all your money. In other words, it’s a measure of how bumpy a ride you have to put up with along the way. Over the long run, financial theory suggests – and history backs this up – that if you are willing to take more risk, then you should get bigger returns.
With a 60/40 portfolio, the idea is that you get a smoother ride than you would with a portfolio that was 100% in risky shares. But you also get better returns than if you were 100% in boring old bonds.
You would also make sure to rebalance your portfolio at least once a year. So for example, if bonds had gone up a lot and now accounted for more than 40% of the portfolio, you would put more money into equities, until you were back to a 60/40 allocation.
The 60/40 portfolio has worked well for some time. However, past performance is not necessarily any guide to future performance. With bond yields now at or near record lows, and concerns about inflation rising, some investors are now questioning whether the 60/40 portfolio will continue to be a good bet in the decades to come.
To find out more about that and about asset allocation in general, subscribe to MoneyWeek magazine.
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