Should clients still follow the 60/40 rule?
For years it has been a rule of thumb that a balanced portfolio should include 60% stocks and 40% bonds.
But with bond yields near record lows and unlikely to rise much soon, should the weighting be cut below 40% for bonds?
Yes, said Mick Heyman, investment counselor at Heyman Investment Counseling in San Diego.
“The 40% bond weighting accomplished two things in the old days,” he said. “It gave you diversification, helping to reduce your risk, and generated income.”
But with interest rates now so low, the income has been reduced.
To make up for that reduction, advisers would do well to have clients invest in high-quality stocks paying ample and rising dividends, Heyman said.
“I believe that’s a better long-term solution," he said.
The dividend increases compound returns.
Heyman recommends a 65% to 70% stock allocation.
“What I’ve been doing with clients who are willing to take this extra risk is to keep at least 50% in core stocks and then the remaining 10% to 20% in quality dividend stocks,” he said. “I’m increasing my equity exposure toward 70%, but I’m using more conservative stocks to do that.”
As for the bond portion of the portfolio, Heyman's clients might put 20% to 25% in safe bonds (Treasuries and high-quality corporates), and they might allocate 10% to 15% to high-yield bonds.
But he sees blue-chip dividend stocks as a stronger play than high-yield bonds because when the stock market drops, those stocks will likely fall less than the junk bonds.
Meanwhile, Chris Litchfield, a retired hedge fund manager and now a private investor in Greenwich, Connecticut, thinks that the 60/40 rule still has value as a “general guideline” for advisers.
He realizes that clients won’t earn much income on the 40% of their portfolio in bonds.
“But it gives you diversification and protection” from stock market drops, Litchfield said.
He worries about advisers who take more risky positions in stocks and bonds to make up for low bond yields.
“In my experience, people lose more money chasing after yield than with any other investment strategy,” Litchfield said.
He also suggests that advisers put clients in individual bonds, as opposed to bond funds because if bond prices fall and they own safe bonds, they can likely hold them to maturity and receive the principal back. But if clients own bond funds, they never mature, so it is more uncertain what they can get back.