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Understanding the Strategy of the 60/40 Portfolio

Understanding the Strategy of the 60/40 Portfolio

Creating a good investment portfolio requires timely and accurate decisions on the right mix of assets that can help you achieve your desired short or long-term goal. One of the most common and easy approaches that even financial advisors recommend is the 60/40 portfolio. Using this system can make the journey to building a good portfolio easy.


What is the 60/40 portfolio?

This strategy involves creating portfolios where 60% are allocated to equities and 40% to bonds. Your portfolio will primarily involve U.S investment before you can use this strategy, though you can build a global portfolio using the 60/40 strategy adding international bonds and stocks.

Theoretically, the 60/40 strategy enables you to keep your portfolio balance maintained when the market dips and when it rises. It is fashioned to help minimize risk while generating a continuous rate of return as time goes on, even in periods of volatility.

The significant advantage of this strategy is that there is a moderation of the risks resulting from the bond allocation. This way, investors can rest and sleep adequately at night.


Building a 60/40 portfolio

Building a 60/40 portfolio by adding investments depends solely on your style of investment.

For example, some investors who feel safe with a self-directed approach can build a good portfolio using low-cost EFTs (Exchange-traded funds). Exchange-traded funds are mutual funds similar to stocks, so you can quickly get the diversification of streamline while utilizing the market movement to your advantage. Also, conventional mutual funds are tax-efficient because these funds' investment does not turn over frequently.

Other investment options can be considered; Real estate investment trusts, dividend-paying stocks for equity allocation. Other options are municipal bonds, which are highly beneficial due to tax-exempt interest; also bonds that can yield high yields; the downside to such bonds, though, is that they are often riskier.

Individual stocks can also be considered, but it’s best to keep in mind that one can't completely control stocks, and even stocks that yield good returns can have bad days. Therefore it is best to allocate stocks rather than putting all of one’s eggs in one stock basket; this leads to a significant loss when the stock drops. The importance of having diversified funds cannot be overemphasized.

When investing in EFTs or mutual funds, focus on the fees, especially the expense ratio. The expense ratio tells you the percentage of a fund’s asset that is utilized in covering its cost of operation each year. 


Does the 60/40 portfolio have any disadvantages?

This strategy is one of the easiest ways to invest; however, there are some downsides to consider. One of the significant disadvantages is that this portfolio will dip in performance over a long period in all equity portfolios due to the effect of compounding interest.

This means you may feel comfortable and safe due to the division of assets, but you will be missing out on a whole of returns. For example, in 1926 to 2017, stocks included in the S and P 500 yielded 10.20% return annually; within this time frame, long term corporate bonds yielded about 6.10% annually, and government bonds yielded 5.50% return annually.

Any investor that wants to stick to this strategy- the 60/40 mix can appreciate so much return on both sides. Still, potentially the portfolio's growth is limited because of the ownership of a smaller percentage of stocks.


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