Introduction

The 60/40 portfolio comprising 60% equities and 40% bonds has long been regarded as a cornerstone investment strategy among financial professionals. Praised for its balance of growth and stability, it is often recommended as a resilient allocation against various global macroeconomic events. However, through the application of financial econometric methodologies, this research challenges the effectiveness of the traditional 60/40 portfolio. The findings will demonstrate its limitations in today’s evolving market environment and propose a more adaptive and potentially superior portfolio allocation as an alternative.

A Brief History of the 60/40 Portfolio

The 60/40 portfolio consisting of 60% equities and 40% fixed income emerged as a foundational investment strategy in the mid-20th century, gaining prominence after the development of Modern Portfolio Theory (MPT) by Harry Markowitz in 1952. MPT introduced the concept of diversification, emphasizing the trade-off between risk and return. The 60/40 allocation was seen as a balanced mix, offering equity-driven growth while using bonds to reduce overall portfolio volatility. Throughout the 1980s and 1990s, this strategy gained widespread adoption among institutional and retail investors, particularly during a period of falling interest rates and strong equity market performance.

Implications of the 60/40 Portfolio

There are several ETF combinations that retail investors can use to replicate a 60/40 portfolio. Among the most common are VOO and BND or IVV and AGG, both of which provide exposure to U.S. equities and investment-grade bonds, respectively. While VOO and IVV both track the S&P 500 Index, and BND and AGG both track versions of the U.S. Aggregate Bond Index, IVV and AGG have longer historical data availability. Therefore, for the purposes of this analysis and to facilitate a longer backtesting period, we will use IVV to represent equity returns and AGG to represent bond returns in constructing the 60/40 portfolio.

Performance Review

The 60/40 portfolio has performed well, delivering nearly 450% cumulative returns since the early 2000s, as shown in Figure 1. However, despite not being fully allocated to equities, the portfolio is still susceptible to significant drawdowns. As illustrated in Figure 2, during the Global Financial Crisis in 2008, the portfolio experienced a drawdown of nearly 34%, and during the COVID-19 crash, it declined by about 20% from peak to trough. These episodes highlight that even diversified portfolios are not immune to major market shocks. When analyzing portfolios, it’s crucial to consider risk-adjusted performance metrics. One of the most cited is the Sharpe Ratio, which is calculated as (Portfolio Return - Risk Free Rate) / Standard Deviation of Returns. However, the key limitation of the Sharpe Ratio lies in its denominator standard deviation, which treats positive and negative returns equally. In reality, investors are more concerned with downside risk, as negative returns typically coincide with increased market volatility and investor stress.

To address this issue, I used a more refined volatility estimate by calculating GJR-GARCH volatility, which better captures asymmetric volatility patterns, particularly during market downturns. As shown in Figure 3, I computed the rolling mean of the GJR-GARCH annualized volatility and used this as the denominator in my risk-adjusted return ratio. the ratio remains below 1, indicating the portfolio’s returns may not sufficiently compensate for its current level of risk. However, as seen in Figure 4, overall volatility has remained relatively low throughout the period. Moreover, GJR-GARCH has proven effective in identifying volatility spikes during key recessionary periods reinforcing its value as a more responsive risk measure. Finally, Figure 5 shows the portfolio’s annual returns. Out of the 22 years covered by ETF data, the portfolio posted only 3 negative years, equating to an 86% up-year percentage and just 13% down-year percentage a testament to its resilience over the long run.

The Revised 60/40 Portfolio Construction

As discussed earlier, the current 60/40 portfolio was originally constructed using domestic equities and domestic bonds. While this traditional allocation has demonstrated reasonable growth, I believe a revised 60/40 portfolio comprising domestic equities, international equities, and gold (replacing bond exposure) could offer a more balanced and diversified approach. From 2005 to mid 2018, gold outperformed both domestic and international equities. Although international equities have underperformed relative to the other two asset classes in recent years, it’s important to note that in the early 2000s, international equities were outperforming domestic equities. This trend persisted until around late 2014, when domestic markets began to lead. This historical shift in relative performance highlights the importance of diversification. By incorporating all three asset classes domestic equities, international equities, and gold—the revised portfolio is better positioned to adapt to changing market leadership and reduce concentration risk.

Without a doubt, the revised 60/40 portfolio which consist of 30% Domestic Equities, 30% International Equities and 40% Gold has delivered significantly better returns and consistently outperformed the original portfolio construction, even amid challenging global macroeconomic conditions. To deepen the analysis, we will now examine drawdowns, volatility, and risk-adjusted metrics to assess whether the revised portfolio also achieved superior performance in terms of risk management and consistency.

Ultimately, throughout this time series, we can conclude that replacing bonds with exposure to international equities and gold has significantly improved the performance of the 60/40 portfolio. Adding international equities, for instance, provides investors with access to emerging and growing economies that may offer higher returns. However, this also introduces international risks such as geopolitical instability. Despite these risks, excluding international markets from a portfolio is not advisable. The United States is not the only engine of global growth, and as prudent investors, we should diversify beyond domestic assets to minimize concentrated risk. Diversification remains key to navigating uncertain economic environments.

Why Remove Bonds and Replace With Gold ?

Bonds can be beneficial for investors, but their effectiveness largely depends on the current macroeconomic environment. Historically, when the Federal Reserve begins raising interest rates, the yield on the 10-year Treasury tends to rise. This increase in yields inversely affects bond prices, causing instruments like the 10-year Treasury futures to decline. At present, we are in a high-interest-rate environment, which is generally unfavorable for bond price ETFs. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) has declined by approximately 17% over the past five years. In contrast, gold has appreciated by about 72% during the same period. Gold is traditionally viewed as a hedge against economic uncertainty. In my opinion, it offers a more resilient core portfolio asset than long-duration Treasury bonds in the current environment, where interest rate direction remains uncertain. Instead of locking capital into longer-duration bonds, investors may be better positioned by allocating to Treasury bills, allowing them to capture higher short-term yields while maintaining flexibility. Below, I present a visual representation of the historical relationship between Treasury bond prices and yields to support this analysis.

Are Equity and Bond Correlations Rising ?

One of the most pressing concerns in today’s market is that bonds are no longer functioning as an effective counterbalance to equities. Traditionally, bonds have served as a defensive asset—rising in value when stocks decline thereby providing diversification and stability within a portfolio. However, this inverse relationship appears to have weakened or even reversed in recent periods. In the analysis below, I will examine the correlation between stock and bond returns across different time frames to assess whether this historical relationship still holds. The findings may offer important insights for investors rethinking the traditional 60/40 portfolio model in the current macroeconomic climate.

Correlations between the S&P 500 and U.S. 10 Year Treasury returns have become increasingly positive, signaling that Treasuries are losing their effectiveness as a hedge against equity market downturns. Historically, U.S. Treasuries were viewed as a safe-haven asset, offering protection and stability during periods of equity market stress. However, the growing alignment in their return patterns suggests they now move more closely in tandem with stocks. As a result, investors may need to explore alternative strategies or asset classes to effectively hedge their equity exposure during times of market uncertainty.

Disclosures

Data gathered for research has been downloaded from publicly available databases. Historical returns are also not predictors of future performance. This is not a recommendation to buy or sell any security mention. Opinions written here are of my own and not of my current employer.