60/40 Portfolio

A 60/40 portfolio gives each part of the mix a job. The 60% in Stocks is the growth engine, owning a share of company profits over decades. The 40% in Bonds pays interest, usually falls far less than stocks in a crash, and serves as a reserve you can sell instead of stocks when markets are down.

The weights are what define it. Left alone, a strong year for stocks might push the mix to 65/35 and a crash might drop it to 50/50, so the portfolio is periodically rebalanced: trimming whatever has grown past its target and adding to whatever has fallen behind. That discipline keeps the risk where you set it.

You can build the mix yourself from index funds or buy it ready-made. The SEC’s investor site names a fund holding 60% stocks and 40% bonds as a common example of a balanced fund, and points out how it differs from a target-date fund: a balanced fund’s mix stays the same, while a target-date fund’s changes as its target date nears.

The case rests on one observation: historically, stocks, bonds and cash have not moved up and down at the same time, so combining them gives a smoother ride than stocks alone while keeping much of their growth. Sixty percent is a middle ground, with enough stock to outpace inflation over long periods and enough bonds that a crash takes a smaller bite.

Retirement research landed in the same neighborhood. William Bengen’s 1994 study, the origin of the 4% rule, advised keeping stocks as close to 75% as possible and never below 50%. The 1998 Trinity study did not test 60/40 exactly, but it tested the mixes on either side: over 30 years of inflation-adjusted 4% withdrawals, a 50/50 portfolio lasted in 95% of the historical periods from 1926 to 1995 and a 75/25 portfolio in 98%.

Those results are history, not a promise. Both studies used US markets only, and the Trinity authors did not adjust for taxes or transaction costs.

A 60/40 mix is a moderate choice, which makes it too cautious for some investors and too aggressive for others. The SEC’s investor site notes that holding only stocks can be reasonable for a 25-year-old saving for retirement, while money for a house down payment may belong entirely in cash equivalents; 60/40 sits between those poles. It tends to suit people within about a decade of retirement, retirees drawing on savings, and investors whose risk tolerance would not survive watching an all-stock portfolio lose a third of its value.

The mix depends on bonds holding up when stocks fall, and in 2022 they did not. To fight inflation, the Federal Reserve began raising its federal funds rate target from near zero in March and reached 4¼–4½% by December, and the 10-year Treasury yield climbed from 1.63% on the first trading day of the year to 3.88% on the last. Because bond prices fall when yields rise, high-quality bonds lost value in the same year as stocks, and a 60/40 portfolio took losses on both sides.

The lesson is not that bonds stopped working but that they protect against some shocks better than others. In a recession-driven crash, investors tend to buy bonds and the 40% cushions the fall. In an inflation and rising-rate shock, stocks and longer-term bonds can fall together. The table below shows how differently the mix handles the two kinds of year.

Some investors respond by shortening the bond side or holding part of it in TIPS, whose principal rises with inflation, or in short-term Treasuries and cash. Higher starting yields also cut the other way: bonds bought after 2022 pay far more interest than bonds bought when the 10-year yield was near 1.6%.

Most investors rebalance on a calendar, such as once or twice a year, or when one side drifts beyond a band set in advance, for example outside 55/45 to 65/35. The SEC’s investor education staff notes that either approach tends to work best when done infrequently.

There are three ways to restore the weights: sell the overweight side and buy the underweight one; direct new contributions to the underweight side; or, in retirement, take withdrawals from the overweight side. The last two avoid selling at all. When you do need to sell, do it inside a 401(k) or IRA if you can, where trades create no tax; in a taxable account, selling appreciated shares realizes capital gains.

Rebalancing is also how the mix defends against sequence-of-returns risk. After a crash, a retiree can fund a year or two of spending from the bond side instead of selling stocks at depressed prices, then rebuild the bonds once stocks recover. The worked example shows the trade after a hypothetical 30% stock decline.