The 60/40 Portfolio Isn't Dead, Just More Expensive

Volatile, pandemic-riven markets for stocks and bonds has Wall Street ready again to declare the traditional 60/40 portfolio split a dead strategy. The prospect of a low-growth, high-inflation economy (stagflation) dims the prospects of both investment categories, and certainly demands a rethink of where to stash your savings. The big banks already are offering advice on alternatives; I've got some of my own. But for investors seeking robust-but-safe returns, there's really just one option: be prepared to take on more risk. The 60/40 ratio 60% stock and 40% bonds has become the go-to portfolio for typical retail investors, providing growth from stocks and stability from bonds. Even a well-diversified collection of stocks can be risky and unpredictable, so bonds protect investors in two ways: they're less volatile and, in normal times, their prices move in the opposite direction of stocks, smoothing out returns. A similar philosophy is behind target-date funds that are offered in many 401(k) plans, which move the portfolio more into bonds as the investor ages. Stocks generally reflect the growth prospects of the economy, and bond yields rise (and prices fall) when inflation goes up. Therein lies the problem: when the economy slows while inflation rises, stocks may fall at the same time bond prices do, nullifying the purpose of a 60/40 split. Even before the pandemic, the financial industry was rethinking 60/40. Bond yields were very low and not offering much return, while stocks kept going up. In typical Wall Street fashion, the solution was to take on more risk. Some banks suggested putting riskier assets like high yield corporate bonds or real estate in the safer 40% part of the portfolio to juice returns. But that just reduced the stability of the portfolio. It would have been simpler to acknowledge that the price of safety had gone up, so accepting more risk, such as with a 70/30 stock-bond split, might be necessary for investors to achieve their desired returns. The post-pandemic economy poses a new challenge to a 60/40 portfolio because the hedging strategy is undermined by the changing relationship between stocks and bonds. Inflation will mean falling bond prices as yields rise, and if higher inflation persists for a few years, bond prices could become more volatile and offer less protection against stock risk. This situation could last for years, or decades. Bank of America has called it the "end of 60-40" (to be honest, this is starting to feel like an annual announcement). Goldman Sachs Group Inc. suggests using stock options to insure against market risk instead. Bank of America Corp. recommends riskier high-yield debt. But stock options may not be a realistic strategy for an unsophisticated investor. And higher-yield assets won't provide a hedge either it merely doubles down on risk. A better solution is investing in assets that will hold their value in a high inflation environment, such as Treasury Inflation-Protected Securities (TIPS). TIPS have only been around for about 20 years, so there isn't enough data to know how their prices would fare during stagflation we've not been in that kind of environment since the 1970s. But since their coupon payments are adjusted for inflation, odds are they will hold their value better than nominal bonds and provide a hedge against possible stagflation. The problem is TIPS could get very expensive since they're one of the few inflation-safe assets available (gold and crypto are incredibly volatile so investing in them introduces new risks well beyond inflation). So a 60/40 portfolio with lots of TIPS on the "safe" side probably won't offer much return. In extreme times like these, when the stock/bond correlations flip, protection becomes much harder to find. Any strategy that offers a hedge will be very pricey, eroding returns. That means many investors won't be able to afford a 60/40 split anymore. They'll need to accept more risk. Whether you should move your portfolio to 70/30, 80/20 or keep 60/40 depends on your risk tolerance. Can you handle a rocky few years in the markets? When do you need to spend the money? Are you willing to forgo some of the market upside for relative safety? There are no easy answers. The only mistake you can make in the current environment is believing you can get something for nothing. Safety is about to get more expensive, and every investor must weigh the trade-offs with clear eyes.

Based on the above article, help to understand the below questions:

• What is the 60/40 portfolio? 60% what and 40% what?
• According to the article, what is the theoretical advantage of this type of portfolio diversification?
• Why does the author write that the post-pandemic economy has poised new challenges to the traditional 60/40 portfolio?
• What are Treasury Inflation Protected Securities? How can they be useful in periods of higher inflation?