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The 60/40 Portfolio: “Wall Street Wisdom” Is Dead Wrong (Again)

Posted December 30, 2023

Zach Scheidt

By Zach Scheidt

The 60/40 Portfolio: “Wall Street Wisdom” Is Dead Wrong (Again)

Remember the “conventional wisdom” about the 60/40 portfolio that we discussed yesterday? 

If you missed it, I recommend you check out the article. (You can read it on our website here.)

In it, I explained how the traditional 60/40 portfolio was crushed when the Fed started raising interest rates, setting investors who followed this “Wall Street wisdom” back years.

Fast forward to 2023, and the conventional wisdom has completely shifted. 

I’ve read several research pieces recently explaining why the 60/40 portfolio is now dead and a terrible approach.

The articles cite the performance of this approach over the last three years, a time when bond prices and stock prices fell in tandem.

Once again, “Wall Street Wisdom” has it all wrong. The 60/40 portfolio wasn’t the Bible in 2020. And it’s not the devil incarnate in 2023. 

It’s an approach that makes sense when investors are getting paid well for their bond and stock investments.

On the other hand, it works terribly when bond prices are extremely high and the stock market is inflated.

Today’s high interest rates give you some great opportunities to invest in bonds. Not only will you receive plenty of interest thanks to today’s higher rates… 

But you also get the potential for some very big capital returns if interest rates pull back. That’s because bond prices rise when interest rates fall.

Today we’ll continue this two-part series, and I’ll explain what this means for you in the year ahead.

It all ties back to one of my biggest predictions for 2024…

My Top Prediction for 2024

I predict that the yield on a 20-year Treasury bond will be cut in half by the end of next year.

The Federal Reserve intentionally drove interest rates higher to slow inflation. We can have an argument about whether this course of action made sense in the post-pandemic economy. 

But traditionally, higher interest rates have been the Fed’s single tool against inflation. 

And for this cycle, the Fed was extremely aggressive in boosting interest rates and putting the brakes on our economy.

Much has been said about the “long and variable lags” of rate policy on the economy. The bottom line is that we know higher interest rates take a long time to work through the economy. 

So, it will still be a few months before the U.S. economy truly adjusts to these higher interest rates.

That means we can expect more pressure on the economy, and the probability of a recession in 2024 is very high. 

What does that mean for interest rates?

Well, just like the Fed’s single tool against inflation is to raise interest rates, the Fed also has one tool to try to support the economy. You guessed it... 

The Fed will have to cut interest rates next year to try to keep us from entering what could be a very challenging recession. 

If we follow the ripple effect through the market, this means there is a very big opportunity for investors to profit from fixed-income plays.

That’s because bond prices will naturally rise when the Fed is forced to cut rates.

Three Fixed-Income Opportunities to Buy Today

While all bonds react to changes in interest rates, there are some key differences between different areas of the bond market.

My first recommendation to profit from higher interest rates is to buy long-term Treasury bonds or a fund that invests in these bonds. 

Remember, long-term bond prices are much more sensitive to changes in interest rates. So, if you’re playing for a pullback in rates, long-term bonds give you the most bang for your buck. 

Most brokerage accounts allow you to invest in individual Treasury bonds. 

And if you’re comfortable navigating your brokerage platform to find these bonds, I recommend buying individual Treasury bonds that mature in 20 years or more. 

But there’s an easier way to invest in this asset class, the iShares 20+ Year Treasury Bond ETF (TLT)

This fund invests in Treasury bonds and trades just like a stock. So, it’s very easy for you to buy and sell in your investment account.

A second way to play a drop in interest rates is to invest in high-quality corporate bonds. 

When you invest in corporate bonds, you’re essentially lending money to companies. So, there’s an additional risk of default that you need to keep in mind.

Fortunately, investors are paid an extra premium for taking on this risk. So, if you buy corporate bonds, you’ll typically receive more interest than if you bought a similar Treasury bond.

One of the best ways I’ve found to invest in this area of the market is to buy a bond fund instead of individual bonds. 

After all, you would need to do extensive research on the individual companies that offer bonds. And many corporate bonds are illiquid and difficult to trade.

The iShares iBoxx Investment Grade Corporate Bond ETF (LQD) is a good way to invest in this area and to have diversification. 

This fund invests in a wide assortment of highly rated corporate bonds. Corporations that issue these high-quality bonds are less likely to default. 

And by investing in a fund, there’s less of a chance that any one default will negatively affect your overall investment.

Finally, a more speculative way to play the upcoming decline in interest rates is to invest in high-yield bonds. 

These bonds are also often referred to as “junk bonds” because there’s a higher chance that companies will default on their debt. 

Because of this risk, high-yield bonds typically pay much more interest to investors. Meanwhile, if interest rates fall in 2024, that factor will be a natural tailwind for high-yield bonds.

Now please note, this is certainly a more speculative area of the market. 

If the broad economy experiences a deeper and more challenging recession, many of these bonds may default. So don’t risk money you can’t afford to lose in this area of the market.

But remember, investors are paid higher yields to take on risk. So over the long term, this speculative area of the fixed-income market could give you outsized returns. 

The iShares iBoxx High Yield Corporate Bond ETF (HYG) is a good proxy for high-yield bonds. You can buy this fund in your brokerage account just like a simple stock.

As we prepare for next year, there are a lot of cross-currents to watch carefully. 

Treasury bonds in particular should offer investors a level of safety and income, while still giving you a chance to grow your wealth significantly.

Make sure you set up your position before rates move any lower!

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