Building a portfolio can be a significantly challenging task for investors. Most investors only consider stock and bond investments when constructing their portfolios. This approach has historically been a safe option for investors. While it increased the rewards they received, it also provided them with a safety net for when they suffered losses.
However, it is also difficult for investors to establish an optimal mix for stocks and bonds in their portfolios. Several factors play a substantial role in what this mix should be. For example, it may depend on the investor’s risk tolerance level, age, experience level, etc. Investors can also use common heuristics to establish a balanced portfolio. One such rule is the 60/40 stock to bond allocation rule.
What is 60/40 Stock to Bond Allocation?
The 60/40 stock to bond allocation rule is straightforward. When establishing a balanced portfolio, investors can use this rule to split their investments. As the name suggests, using this approach, investors must divide their portfolios into 60% stocks and 40% bonds. This approach to investing has been significantly successful historically. However, it has also had its fair share of drawbacks.
A 60/40 stock to bond allocation portfolio constitutes a high-risk portfolio. Usually, investors include 60% of stocks in their portfolios for growth. However, they also hold 40%bonds and other fixed-income securities to mitigate any specific risk. Investors usually include bonds and securities that can lower the risks associated with their particular stock investments.
How does the 60/40 Stock to Bond Allocation work?
The 60/40 stock to bond allocation technique is an approach towards determining a portfolio mix. Unlike other methods, it has a fixed ratio for allocating investments in a portfolio. As mentioned, it works by using a 60% allocation for stocks or equity instruments. The remaining percentage, 40%, goes towards bonds and other fixed-income instruments.
For example, an investor wants to allocate a portfolio of $10,000 into different asset classes. They settle at using the 60/40 stock to bond allocation technique. Using this approach, they buy stocks worth $6,000 to include in their portfolio. For the remaining amount, $4,000, they acquire various corporation and municipality bonds.
Using the 60/40 stock to bond allocation technique can be helpful. However, there are several factors that play a role in whether investors will use this ratio. Usually, they take a risk assessment to determine whether this technique can help them with their risks. In some cases, they may also opt for a different split, such as 50/50 or 40/60 stock to bond allocation.
Is the 60/40 Stock to Bond Allocation beneficial?
The 60/40 stock to bond allocation technique has been one of the favourites splits for investors. Historically, it was a preferred method for investors to distribute their funds. It can be beneficial in providing investors with protection during market or economic downturns. Similarly, it can also help them increase their returns and achieve growth.
In recent years, however, the 60/40 stock to bond allocation technique has illustrated various drawbacks. In particular, the low or slow return that investors get from their debt instruments is critical with this technique. For most investors, the optimal portfolio split ultimately comes down to their circumstances.
Conclusion
There are several techniques that investors can use when establishing a balanced portfolio. The 60/40 stock to bond allocation technique helps investors split their portfolios into stocks and bonds. With this approach, investors include 60% stocks and 40% bonds in their portfolios. While it can be beneficial, the 60/40 stock to bond allocation split has become outdated.
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