The evolution of the 60/40 investment strategy in the face of new economic realities

The 60/40 investment strategy, long considered the gold standard for asset allocation, is generating growing debate in financial circles. This classic approach, which involves allocating 60% of capital to stocks and 40% to bonds, was developed to achieve an optimal balance between capital growth and capital protection. However, it is now being challenged in an economic context profoundly disrupted by the 2008 financial crisis and the repercussions of the Wuhan pandemic.

In this article, we will start by examining the evolution of the 60/40 approach while highlighting the challenges it faces today. We will then explore various alternative strategies and the sub-asset classes relevant for portfolio construction. After completing this analysis, we will turn our attention to the most essential section: backtesting. We will examine the results of all the configurations presented, as well as other potential scenarios. Finally, we will provide a summary of the 60/40 approach taking into account the current context.

The 60/40 Strategy: Historical Fundamentals

The 60/40 strategy was created in the 1950s, at a time when financial markets were less complex than they are today. Its foundations are based on modern portfolio theory, developed by the eminent Nobel Prize winners in economics, William Sharpe and Harry Markowitz. Legendary investor Benjamin Graham already presented, in his 1949 book, "The Smart Investor", a portfolio that follows roughly a similar philosophy, with 50 % of stocks and 50 % of bonds.

Since its inception 75 years ago, the 60/40 model has been declined in many ways, with various variations concerning the sub-asset classes and subtle adjustments to the weightings. The stocks have been selected according to geographic, sectoral or capitalization category criteria. Similarly, the bonds have been chosen according to their duration to maturity, their level of risk, the type of issuer (corporate or government), or their region of origin. However, in the end, it remains a 60/40 portfolio, with a few nuances. The name changes, but the content remains the same.

The 60/40 ratio has thus established itself as an effective solution for investors seeking to benefit from both the growth potential of stocks and the stability of bonds. Stocks generate superior returns over the long term, while bonds play a defensive role. Historically, this strategy has demonstrated its robustness by going through different economic cycles. It has worked particularly well during periods of strong inflation 1970s and 1980s, when bonds offered high yields.

The simplicity of implementation and ease of understanding of this strategy have contributed to its popularity among institutional and individual investors. It has become a standard in the asset management industry.

John C. Bogle & the Bogleheads

While the 60/40 portfolio was invented by legends Harry Markowitz, William Sharpe, and Benjamin Graham, it was Vanguard founder John C. Bogle who truly popularized the model among the general public. Bogle’s advocacy of passive investing and simplicity helped inspire generations of retail investors to adopt the strategy. By advocating a buy-and-hold approach, Bogle championed the idea that most investors would benefit from diversified exposure through low-cost index funds.

His philosophy resonated with many retail investors, eager to maximize their returns while minimizing fees. The Boglehead community emerged in the 1990s, largely due to his influence. One of the catalysts for the formation of this community was the publication of his book, "Common Sense on Mutual Funds", which popularized the idea that most investors could achieve their financial goals without relying on high-compensation asset managers.

Bogleheads, as they are known, have gathered around online forums, where they exchange investment advice and strategies, part of a broader movement to democratize investing. Their approach emphasizes asset allocation, often inspired by the 60/40 model. It advocates a long-term investment discipline, centered on simplicity and passive investing through low-cost index funds.

Market developments call into question the approach

The low interest rate environment that has persisted since the 2008 financial crisis has had a profound and lasting impact on the global economic and financial landscape. This prolonged period of low interest rates has not only changed investor expectations, but has also led to a fundamental rethink of how investment portfolios are constructed and managed. Historically low bond yields, often below inflation, are calling into question the relevance of the traditional fixed income component, once considered a steadfast pillar of any investment strategy.

Unconventional monetary policies adopted by central banks, such as quantitative easing and near-zero interest rates, have also created significant distortions in financial markets. In this context, the massive injection of liquidity into the economic system has contributed to increasing asset valuations, leading to a volatility increased and sometimes irrational behavior in the markets. As a result, investors have had to rethink their strategies to adapt their portfolios to this new reality.

Correlations between stocks and bonds

The 60/40 ratio is often seen as very advantageous in terms of return and risk, due to the historically low or even negative correlation between stocks and bonds, which has been particularly pronounced since the 1990s. This means that bonds can provide protection against losses in the stock market. However, it should be noted that current correlations between these two asset classes have become more erratic and less predictable. In times of market stress, we now see synchronized movements between stocks and bonds.

It should be noted that the phenomenon of positive correlations between stocks and bonds is not exactly new. I already talked about it in 2017. This behavior tends to occur during periods of rising interest rates, as observed not only after the COVID-19 pandemic, but also during the Thirty Glorious Years, particularly in 1969. In such circumstances, bonds, traditionally considered safe havens, can depreciate as investors anticipate tight monetary policies. This dynamic causes bonds to lose their ability to behave independently of equity markets, thereby reducing the benefits of the 60/40 model.

However, reducing the benefits does not mean eliminating them. Even in a context of positive correlation, the impact on a 60/40 portfolio remains relatively modest over the long term. Periods of monetary tightening are not unprecedented. Some institutional investors seem to have overlooked this aspect and are now playing the role of startled virgins, wanting to throw bonds out the window. This could actually represent an opportunity for the 60/40 strategy.

The 70/30

The 70/30 portfolio is an alternative that is gaining popularity among investors seeking higher returns while seeking to navigate an uncertain economic environment. By allocating 70% of capital to equities and 30% to bonds, this approach aims to increase the share of growth, taking advantage of the greater potential of equity markets, while maintaining some protection offered by bonds. Historically, the 70/30 portfolio has often been seen as an attractive compromise between the classic 60/40 and more aggressive allocations, offering slightly higher risk, but with the benefit of increased exposure to stock market rents.

Since equities tend to generate higher returns over the long term, this model may be particularly attractive to investors with a long time horizon who can afford to tolerate more short-term volatility. However, it should be noted that this move to a 70/30 portfolio should not be made without careful analysis of individual investment objectives, risk tolerance levels and market conditions.

Graham's Classic 50/50

Benjamin Graham, in his book "The Intelligent Investor," advocates a 50/50 asset allocation, splitting investments equally between stocks and bonds. This approach, while less common than the classic 60/40 model, can serve as a bulwark against wild market fluctuations while still allowing investors to benefit from the long-term returns typically offered by stocks.

This strategy reflects Graham’s philosophy of taking a cautious approach to economic uncertainty. Although often overlooked in modern allocations, Graham’s 50/50 approach is worth rediscovering, especially in an environment of increased volatility.

Static and dynamic asset allocations

Static (or strategic) allocation, characterized by a fixed distribution of 60 % of stocks and 40 % of bonds, has long been the preferred choice of investors. This method is based on the conviction that, over the long term, this combination offers an optimal balance between return and risk. However, with the contemporary challenges shaking the markets, dynamic (or tactical) allocation is beginning to attract more and more investors.

Dynamic allocation allows asset weightings to be adjusted based on market conditions. In times of high volatility or economic uncertainty, investors may choose to reduce their equity exposure to lock in gains. This allows for faster response to market movements, potentially improving the risk-return ratio.

Approaches such as risk parity focus on volatility and correlation to weight asset classes, seeking to optimize return on a risk-adjusted basis, which can provide additional protection in an uncertain market environment.

Age-based allowance

Age allocation is an investment approach that considers an investor's age as a key factor in determining the allocation of assets between stocks and bonds. This method is based on the idea that as a person ages, their ability to absorb risk declines, requiring an adjustment in the composition of their portfolio toward less volatile assets, such as bonds. The common rule of thumb is that an investor should allocate a percentage of their portfolio to bonds that is equal to their age. For example, a 30-year-old investor should have 30% of their portfolio in bonds and 70% in stocks, while a 60-year-old investor should allocate 60% to bonds.

While this method offers simplicity of application and a conservative approach to capital protection, it also has limitations. It does not take into account individual financial situations or specific needs, which may lead to an inappropriate allocation for some investors. In addition, it may result in insufficient exposure to equities during bull markets, thereby reducing the growth potential of assets.

So, while age-based allocation is a popular approach, some caution should be exercised and consideration should be given to customizing asset allocation based on each investor's unique circumstances and objectives.

Asset Subclasses

The sub-asset classes that can be used in a 60/40 portfolio can greatly influence the overall return and risk of the strategy. Beyond the simple distinction between stocks and bonds, it is necessary to explore the various asset classes and types that can be integrated to optimize the allocation.

For stocks, investors may want to consider diversifying not only by sector (technology, healthcare, consumer, etc.), but also by geography or by company capitalization.

For bonds, several subclasses can be included within a 60/40 allocation, depending on the type of issuer (government or corporate), their credit rating (Investment Grade or High Yield), their maturity level (short, medium or long) or their country of origin.

ETFs

ETFs and index funds are convenient instruments to access these sub-asset classes, making it easier to manage a balanced portfolio. my article dedicated to ETFs, you will discover a complete range of ETFs covering the mentioned sub-asset classes, making it relatively easy to implement a 60/40 strategy.

In the backtests that follow, I will use several of these instruments, complementing them with other listed funds, particularly for Swiss and international bonds. Here are the ETFs that are retained for the backtests:

• US Stocks: SPY, QQQ, VDC, XLV
• Swiss stocks: EWL
• Global Equities: VT
• Long Maturity US Government Bonds: TLT
• US Government Bonds 7-10 years: IEF
• US Government Bonds 3-7 Years: IEI
• US Corporate Grade Bonds: LQD
• High Yield US corporate bonds: HYG
• US Government and Corporate Grade Bonds: BND
• CH 7-15 year government bonds: CSBGC0
• CH 3-7 year government bonds: CSBGC7
• Corporate Grade Bonds CH: CHESG
• Government bonds of developed countries outside the USA: BWX
• Corporate Grade Bonds from Developed Countries outside the US: IBND
• High Yield Corporate Bonds from Developed Countries Outside the USA: HYXU
• Emerging Market Corporate Bonds: CEMB
• Emerging Market Government Bonds: EMB

If there are significantly more choices for bonds, it is because we have already reviewed and selected the best ones Stock ETFs to build portfolios. Even though EWL and VT did not show amazing results, I keep them as a benchmark.

Regarding bond ETFs, we had already noted the following elements :

• TLT shows the strongest negative correlation with SPY, i.e. with the US stock market. It is a strong asset in terms of diversification, especially when the stock market falls. It is effective in reducing the volatility of the PF.
• IEF is negatively correlated to SPY, but less than TLT. In addition, it is highly correlated to the latter. It is therefore less effective than TLT in diversifying and lowering the volatility of a portfolio.
• Corporate bonds, whether high quality (LQD) or high-yield (HYG) are significantly correlated to SPY (especially HYG). They therefore do not provide anything in terms of diversification, especially since long-term profitability is quite low.

We will now look at the results of combining all of these elements in a 60/40 split portfolio, as well as in other configurations.

Backtests

The backtests are broken down into five sections:

• the classic 60/40 (itself broken down into five lots)
• alternative static allocations, with other weightings
• the 60/40 in its dynamic version, with an allocation that adapts according to market conditions
• age-based allowance
• possible developments of 60/40

For each section, we will examine the performance of different sub-asset classes using the ETFs mentioned above. As we backtest, we will eliminate the least relevant ETFs, allowing us to focus on the best choices and avoid an overabundance of unnecessary tests.

For each backtest, an annual rebalancing is performed to match the allocations to the target.

60/40 static

1st batch

We start with an analysis of 11 bond ETFs and 3 equity ETFs, resulting in 33 different backtests. To this, we add a line with an allocation of 100 % on the SPY ETF, which serves as a reference. The backtests extend from 2008 to 2024. The minimum limit of this analysis is dictated by the VT ETF, which is the “youngest” of the funds we examine in this first batch. The portfolios are ranked from best to worst Sharpe ratio, which allows us to evaluate the performance of the different strategies with equal risk. The performance is based on the Swiss franc (CHF).

Findings

• Regarding the actions:
  • No surprise, portfolios with EWL and VT are clearly lagging behind those with SPY. We have already highlighted this phenomenon in our article dedicated to the 100% equity portfolio. There is therefore no particular symbiosis with bonds that would enhance these ETFs.
  • SPY alone is in third place on the podium, which can be explained by the low rates during this period.
• Regarding obligations: 
  • Portfolios with BWX (government bonds of developed countries outside the US) show a rather miserable result. This means that those made with IBND and HYXU, which we have not tested here, risk being so too. We will check this later.
  • Emerging market bonds (EMB and CEMB), as well as high-yield US corporate bonds (HYG), allow portfolios to show good profitability (CAGR). However, the associated volatility is significant. As a result, the Sharpe ratio is not extraordinary.
  • The combination of Swiss government bonds and US stocks is the best combination. This is reminiscent of the combination of SRFCHA and SPY that we saw in our article on the real estate portfolio. This is a bit of a surprise, given the miserable rates offered by confederation bonds over this period. This is however explained by a very slightly negative correlation of bond ETFs (-0.1 for CSBGC7 and -0.08 for CSBGC0) with SPY. The CAGR of these combos are lower than SPY alone, but in return the risk is lower and therefore the Sharpe ratio higher. The portfolios with Swiss government bonds and SPY are also the only ones to beat SPY alone.
  • A surprise emerges from these backtests: portfolios containing US corporate grade bonds (LQD) and US government bonds of 7 to 10 years (IEF) obtain better Sharpe ratios than those containing long-maturity government bonds (TLT). However, the traditionally lower correlation of TLT with SPY should work in its favor. This may be due to the post-China virus rate hike phase. It will be necessary to monitor what this gives over the longer term, given that the period here is relatively short.

Among the portfolios analyzed, the 60/40 model composed of VT and BND ranks in the lower half of the table. This allocation was popularized by Rick Ferri, an influential author in the Boglehead community. This is a classic 60/40, which shows rather modest results. Ferri also offers a portfolio which is divided into three funds : 40 % VTI, 20 % VXUS and 40 % BND. The latter is an exact replica of the former, spread across three ETFs. Indeed, VTI, which we discussed in our article on stock portfolios, reproduces the US stock market and VXUS represents the international stock market, outside the USA. Since VT is made up of 2/3 US stocks, we therefore find exactly the same proportions: 2/3 of 60% of VT = 40% of VTI and 1/3 of 60% of VT = 20% of VXUS. Same ingredients, same results.

John C. Bogle and his Bogleheads deserve credit for popularizing the 60/40, but their stubborn insistence on keeping things simple means that their system has not evolved since the original contributions of legends Markowitz, Sharpe, and Graham. This is a good thing in itself, but in this case, credit where credit is due. Yet today, when the 60/40 portfolio is mentioned, Bogle's name comes up first. On the subject of simplicity, Albert Einstein, another Nobel Prize winner, said: "Everything should be done as simply as possible, but not simpler than necessary." Just as profitability cannot be achieved at the expense of risk, simplicity must not be achieved at the expense of results.

The Bogleheads include a number of popular investment book authors among their members, including Taylor Larimore, Mel Lindauer, Michael LeBoeuf, and Rick Ferri. There are also among the contributors to the John C. Bogle Center, who is behind the Bogleheads, a significant number of authors, executives or directors of financial consulting firms. The Bogle Center Board of Directors is headed by Christine Benz, who is also the director of personal finance and planning. retirement at Morningstar. She has published numerous books on Amazon. The same goes for William Bernstein, board member of the John Bogle Center, co-founder of Efficient Frontier Advisors, an investment management firm, and a prolific author on Amazon. I'll stop there, because the list is quite long.

I have no problem with them promoting their products and companies, but in this case there's a contradiction: either the method is simple and inexpensive, in which case it deserves just a few free-access posts, or it's sufficiently complex to merit added value, via specialized books and paid services. Taylor Larimore's "The Bogleheads' Guide to the Three-Fund Portfolio", which he presents as a "revolutionary guide", is a case in point: $18 for 118 pages, devoted solely to the three-fund portfolio, whose Rick Ferri variant we saw above. I haven't and won't read this book, which has nothing "revolutionary" about it, since it's based on a 75-year-old strategy. So I'll leave it to the critics ofAmazon :

• There's no real information in this book other than "use Vanguard's three funds to simplify your portfolio, reduce fees and outperform managed funds (remember, Vanguard was founded by John Bogle).
• This "book" could have been condensed into a 6-page article. I read the whole thing in less than an hour and came away unimpressed. Don't buy it unless you're a complete novice.
• A simple message in a simple "book". It's really just a brochure for Vanguard and the story of loyal bogleheads.
• Rather, it's a Vanguard book recommending three index funds and the whole book revolves around that.
• It's a bit too important a selling point for Vanguard funds for me to consider it completely objective.
• Much of this book is made up of "testimonials" from people who use the Bogleheads website. It's only worth reading if you have NO knowledge of investing/finance. Everything in it can easily be obtained by reading a few web pages.
• I feel like I've paid for a small book to have 50% from it quoting people praising the method, 20% promoting products/brokers and 20% useful information. Sounds like brainwashing.

It's worth noting that this live show also receives very good ratings. In fact, it received 4.5/5 stars from just over 1,000 ratings. These figures should be put into perspective, however, bearing in mind that the Bogle community numbers, according to them, more than 130,000 membersThe three-fund portfolio is, according to Larimore, "the most popular on the Bogleheads forum".

2nd batch

In this 2nd batch, we'll be taking a closer look at the bond ETFs we haven't yet covered: CHESG, HYXU and IBND. We left them aside because of their shorter track record. We'll compare them to the best strategies of the previous batch, but over a shorter time horizon, from 2012 to 2024. The worst-performing equity ETFs (EWL and VT) will now be omitted.

In the previous backtest, we hypothesized that portfolios with HYXU and IBND might post disappointing results, given those obtained with BWX (these three ETFs concern bonds from developed countries outside the USA). As for CHESG (Swiss corporate grade bonds), we should be pleasantly surprised, given the interesting results obtained by Swiss government bonds and US corporate grade bonds. Here are the results of the backtests:

Findings

• Our hypothesis concerning HYXU and IBND is confirmed. Both portfolios are at the bottom of the ranking.
• The CHESG portfolio performed better. However, it still lags behind those with Swiss government bonds.
• SPY alone is the best strategy, even for the Sharpe ratio. This can be explained by the fact that the equity market performed particularly well during the period under analysis. In the longer term, as we saw with Batch 1, the addition of Swiss government bonds provides a better Sharpe ratio.
• The portfolio with TLT is once again outstripped by the one with IEF. It is even ahead of the portfolio with IEI. On the other hand, it is ahead of the portfolio with LQD.

3rd batch

This time we're going further back in time, going beyond the starting date used for the first batch, which was limited by VT. Thanks to a new point of origin set in 2004, our backtests now cover a full 20 years. This has enabled us to deepen and shed more light on some of the findings we mentioned earlier.

Findings

• Portfolios with Swiss bonds are still very well positioned.
• SPY alone is still on the podium. It's a trend that's definitely confirmed and raises questions about the 60/40 strategy.
• The portfolio with TLT still trails that with IEF, but the difference is narrowing. What's more, it is now ahead of those with LQD and IEI.

4th batch

This time, we're going all the way back to 1995, giving us almost thirty years of data. To do this, we'll have to focus on US ETFs, as Swiss bond ETFs are too "young" to go back that far. This extended time coverage will help us to better understand the sometimes surprising results of certain portfolios.

Findings

• SPY (alone) tops the podium, helped in this test by the absence of Swiss government bonds.
• The differences between the Sharpe ratios of the different strategies are relatively small.
• The portfolio with TLT is now ahead of IEF. Over almost 30 years, this is the best 60/40 strategy.
• If we had been able to go back further, to the early 1980s (ETFs only appeared in 1993), we would have obtained a result even more in favor of TLT. The SPY-only portfolio would have had to relinquish its top position, due to the very high bond yields in the early 1980s, followed by a long, stainless-steel downturn (driving up bond prices).
• Portfolios with BND, LQD and IEI perform less well than in previous tests. This is due to a higher correlation with SPY than with other bond ETFs.

Let's briefly recap. So far, we've seen that :

• Among equity ETFs, SPY is the best choice for a 60/40 portfolio.
• Among bond ETFs, CSBGC0 represents the best medium-term opportunity
• Over the longer term, TLT is an attractive option.
• The other bond ETFs do nothing. They weigh not only on the CAGR, but also on the Sharpe ratio. A portfolio made up entirely of SPYs achieves better results, even for the Sharpe ratio.

5th batch

We are back in 2004, which will allow us to reintroduce CSBGC0 and this time we will use our triad of ETFs (QQQ/VDC/XLV) rather than SPY. As a reminder, the latter had obtained a Sharpe ratio of 0.66 during this period, with a CAGR of 9.67.

Not surprisingly, the 60/40 PF composed of the triad of equity ETFs and CSBGC0 performed very well. The Sharpe ratio is superior to that of the triad itself and to that of the portfolios analyzed. It's the best 60/40 we've tested. It reconciles us somewhat with the mediocre results obtained with all the others. And there were plenty of them.

We're now going to see if this portfolio performs better when we adjust the weightings a little. We're therefore moving away from the strict 60/40 framework, but this will give us a different perspective.

Alternative static weights

We have already briefly discussed 70/30 and 50/50 portfolios above. Here, we'll take a look at several alternative allocations with a more or less pronounced equity component. Obviously, the higher the latter, the higher the CAGR. But what about the Sharpe ratio?

Findings

• The 70/30 has a Sharpe ratio identical to the 60/40, but with a slightly higher CAGR, which is logical given the equity component.
• The 50/50 also has an equal Sharpe ratio, but this time with a lower CAGR. Again, this makes sense.
• The tipping point for the Sharpe ratio is above the thresholds of 50% and 70% in equities.
• The 40/60 and 80/20 portfolios close the ranking, although the difference in terms of Sharpe ratio is small.
• Weightings have far less impact on the Sharpe ratio than the judicious choice of asset subclasses.

No matter how hard we try to reinvent the wheel, the ideal portfolio still remains around the famous 60/40. Investors with a greater tolerance for risk can set their sights on the 70/30, the less reckless on the 50/50 and everyone else on the original 60/40.

60/40 dynamic

The principle of dynamic allocation was mentioned above. As a reminder, this allows you to adjust asset weightings according to market conditions. A relatively easy way of doing this, which I explain in my bookis to use inverse volatility. In the example below, I've used the 60-day volatility. To simplify the analysis, this time I've limited the backtest to a basic SPY/TLT allocation. This is all we need to determine the relevance of the dynamic allocation.

The results, although quite similar to static allocation, are somewhat disappointing. However, this system works quite well with other strategies, in particular adaptive allocation, which I mention in my book, and which involves more asset classes.

Once again, no matter how hard we try, we always end up going back to the classic 60/40 invented 3/4 of a century ago.

Age-based allowance

The "your age in bonds" allocation we mentioned earlier is an approach widely adopted by many investors, including Bogleheads. As its name suggests, this approach aims to set the proportion of bonds in a portfolio according to the age of the person concerned: 25% at age 25, 26% at age 26 and so on.

The advantages of this approach lie in its simplicity and its ability to embody a prudent philosophy. By gradually reducing equity allocations, it aims to protect capital from market fluctuations, which a priori seems relevant to investors nearing retirement, seeking to preserve their assets to finance future needs. This method can also offer a certain peace of mind, as it offers a clear, easy-to-follow strategy.

However, the rigid application of this rule also has many disadvantages. Remember what Albert Einstein said about simplicity. We'll look at each of them below.

Individual characteristics

The "age = obligations" rule does not take into account individual financial needs, risk tolerance or goals. A person may have adequate financial resources to remain invested in equities even into their fifties or sixties. Or they may aim to maximize their wealth in retirement, with their heirs in mind.

This strategy is based on the partly mistaken idea that, with age, a person's risk tolerance decreases. However, over the years, investment knowledge and experience tend to strengthen it. Take my personal example, a 50-year-old investor today, who started investing at the age of 25, in 2000. If I had followed the "age = bonds" rule, I would have had to devote 75% of my nest egg to equities, at the dawn of the "lost decade" 2000-2009. This was the most calamitous decade in history for Wall Street, the only one to post a negative result (even the Great Depression of the 1930s ended with a positive return on investment thanks to dividends). At 25, you're not equipped for that. It's true that you're never really there, but experience allows you to get through it a little more serenely. Today, on the contrary, if I followed this stupid rule, I'd have to allocate 50% of my portfolio to bonds, in a context that's not very favorable to them, and when I know how to manage losses much better than when I started. What's more, if all goes well, I have a good thirty years of life left, which is even longer than the 25 years since I started trading.

The "age = obligations" formula reminds me of the one used by some amateur runners to establish their training zone based on maximum heart rate (220 - age). This crude approximation doesn't take into account the individual's genetics or fitness level. Experienced athletes and professionals know that this martingale is too approximate to work properly. They prefer to rely on lactic threshold, an indicator that reflects their individual characteristics and enables them to train at the appropriate intensity.

The same applies to investing: the "age = bonds" rule is a crude approximation that fails to take into account the individual characteristics of investors. Just as a runner can fine-tune his training zone according to his lactic threshold, an investor must adapt his asset allocation according to his personal situation, experience, financial objectives and, as we shall now see, market conditions.

Market conditions

The other big pitfall of age-based allocation is that this strategy completely ignores market conditions. The market, however, doesn't give a damn about your age. You could be 20 years old in 1980 and be allocated just 20% in bonds, at the dawn of four decades that are overwhelmingly in their favor. Conversely, you could be 70 in 2009 and invested only 30% in equities, on the eve of the longest bull market in history.

Relying on such a rigid rule carries the risk of finding oneself out of step with market dynamics, especially in the current context of bond yields below their historical average. We tend to forget that bonds can also lose value, particularly when interest rates rise. This can have a direct impact on portfolio profitability and risk. Take, for example, 10-year U.S. Treasuries, which are considered a safe asset. Between 2021 and 2022, they lost 30% of their dollar value. As for long-term bonds (20 years and more), their performance in 2022 was even worse than that of equities (-30% versus -20% in USD).

A concept that theoretically does not hold water

As we saw above, the Sharpe ratio is at its highest when bonds represent between 30% and 50% of the portfolio. This means that if you follow the "your age in bonds" rule to the letter, you end up with a declining Sharpe ratio beyond the age of 50. As I explain in my bookThis ratio is directly correlated to the risk-free withdrawal rate, which represents the proportion of your capital that you can consume while being sure you won't end up on the street. So, at an age when you're about to start drawing down your capital to retire, your withdrawal rate is no longer optimal. Worse still, if you continue to follow this arbitrary rule, your withdrawal rate will fall again and again, with the unfortunate consequence of reducing your income or even bankrupting you.

As a result, the more bonds retirees hold in their portfolios, the more they have to spend. risk of running out of money in retirement. Taking the "age = bonds" rule to its extreme, Jeanne Calment would have had to short-sell shares representing 20% of her portfolio's value in order to buy an equivalent amount in bonds. While this strategy may make sense in a bear market, it carries significant risks during a bull market: in 2009 and 2013Shares jumped by more than 26%, respectively 32%, while bonds lost 11%, respectively 9%. Fortunately for her, Jeanne Calment had "already" passed away by then...

In reality, it doesn't work either.

THE target-date funds represent a concrete, commercial application of the "age=obligation" rule. These funds are automatically adjusted over the years as they approach a specific date (which may be the start of retirement). Asset allocation gradually evolves towards more conservative investment choices, thus reducing the risk of losses as the target date approaches. Or, these funds require 61 % more in savings for retirement than a 100% equity strategy.

In fact, an equity-only allocation outperforms age-balanced strategies, even in retirement, up to age 90 ! My own backtests, which we'll look at later, confirm that the 100% shares do indeed fare better than the "age in bonds", with one small caveat: the capital withdrawal must have started at age 65 or less. In principle, this is the case, but you never know. In the unlikely event that the drawdown begins at age 70 or over, it's best to opt for a balanced portfolio such as 60/40 or 50/50. Even in this situation, we're still a long way from the "your age in bonds" rule.

Do as I say, not as I do

Paradoxically, while recommending the "Your age in obligations" ruleJohn C. Bogle did not apply it to his own assets. He retained a 60/40 allocation until he was 86, when he switched to 50/50. At that age, however, according to the rule, his portfolio should have contained almost 90% of bonds!

This indicates that, despite his advocacy of a cautious, simplistic approach to investing, he may have perceived a more nuanced balance between growth and capital protection, tailored to his personal circumstances, long-term financial goals and market conditions. In other words, his strategy illustrates a fundamental concept: best investment practice should be flexible and tailored to the individual, rather than blindly following general rules.

Capital survival rate

To shed some light on all this, we're going to take a look at an essential concept in wealth management: the capital survival rate. This refers to the probability that invested capital will remain at a level sufficient to finance a person's financial needs throughout retirement. More precisely, it measures a portfolio's ability to generate adequate income (including inflation), while preserving the initial capital for future use.

The calculation of the capital survival rate takes into account the length of retirement, the withdrawal rate (the proportion of capital that is withdrawn each year to cover expenses), inflation and the rate of return that the portfolio is likely to generate. If the withdrawal rate is too high in relation to the return on capital, it increases the risk of depleting financial resources. Conversely, a moderate withdrawal rate, combined with sustained returns, can maintain capital at a healthy level over time.

For the analysis, we'll be using US market data, from 1927 to 2023. Unfortunately, the Swiss and European markets are missing, but on the other hand, we have access to a very extensive history, covering the major stock market events of modern finance. This gives us the assurance that our portfolio models are confronted with the worst possible known conditions.

Backtesting involves creating a portfolio based on a predefined asset allocation, then monitoring its evolution while withdrawing money from it at a specific withdrawal rate. This process starts in 1927 and continues until the end of the planned withdrawal period (e.g. 30 years), after which it starts again in 1928, and so on. Then we look at how many times the capital has managed to survive despite successive withdrawals. If the success rate reaches 100 %, this means that, in every scenario considered, the portfolio has managed to hold its own, even during the most difficult periods, such as the Great Depression, the 1970s and the 2000s. On the other hand, a lower success rate indicates that there is a risk associated with retirement with this asset allocation, taking into account the specified withdrawal rate.

The left-hand column of the table below shows, as usual, our different portfolios. At the top, you'll find the starting age of the withdrawal phase, ranging from financial independence acquired very early on (age 45), to more traditional retirement (age 60-65). I've also added two columns (70-75 years) for the very rare case of a late withdrawal of wealth. The capital withdrawal rate shown below is adapted to the retirement age. The earlier the retirement age, the longer the withdrawal phase and the lower the withdrawal rate. In order to give all the portfolios tested the best possible chance of success, I have used more conservative withdrawal rates than those referenced in my work. In orange, the result is the allocation recommended by the "age=obligations" rule.

It is assumed that the portfolio holder lives to age 85. The model can also be applied in the event of a "desired" death later than this reference age. If we want to take a five-year safety margin, for example, i.e. up to age 90, this means that the withdrawal phase is that much longer. In this case, please refer to the retirement age column in the table above, from which the desired additional years will be subtracted. For example, if you wish to retire at age 65 and live to age 90 instead of 85: 65-(90-85)=60. In this case, we use the 60 years column to determine the most suitable portfolio to last from age 65 to 90.

The backtest also assumes that the allocation remains fixed after retirement. The portfolios mentioned in the first column are therefore kept unchanged until age 85. For example, with a retirement age of 60, a portfolio of 100% in equities, kept unchanged until the end (age 85), has a 100% chance of surviving with the withdrawal rate used (3.6%). We'll discuss below what happens if the investor adjusts his allocation along the way.

Findings

• Despite the use of conservative withdrawal rates, the "Your age in bonds" rule entails a small risk of bankruptcy for all pensions started before age 70. The risk is fairly low (<5.2%), but the consequences are obviously very significant.
• Only in the rare case of very late retirement, at age 70 and beyond, does the age rule show a survival rate of 100%. However, all other allocations with an equity component of 60% or less also show a success rate of 100%, with, of course, greater earnings potential.
• The 60/40 is not without its faults. In fact, it only achieves 100% of success in the case of very late retirement. Nevertheless, the results are better than "age in bonds", especially for retirements from the age of 55.
• the 70/20, while not perfect, fares best in most situations, which is logical given that it has the best CAGR among portfolios with the best Sharpe ratio.
• The 100% SPY is systematically better than "age in bonds", except for very late retirements (age 70 and over).
• There's a tipping point for all pensions starting at age 70 and beyond. As soon as this point is reached, approaches comprising at least 40% in bonds become safer than those with a high equity component. These results are perfectly logical and consistent with J. Siegel's conclusions in "Stocks for the Long Run"A twenty-year investment horizon is required for equity volatility to fall below that of bonds.

The problem with the "age in bonds" arises mainly from the initial allocation, i.e. that at the start of the withdrawal phase. Here, the equity portion is far too low for the portfolio to survive systematically for at least twenty years. The fact that the proportion of bonds increases with age is far less penalizing. In fact, if we continue to lower the equity portion during the withdrawal phase, we obtain virtually the same figures as above. This is logical, since it reduces portfolio volatility as you approach the "finish line". However, for capital to survive, you need to start with a much lower bond allocation.

If you really want to stick to a formula, it's best to use: age - 30 = obligations. However, once again, this rule takes neither your individual characteristics nor the market into account. What's more, as we saw above, a formula of this type is not necessary, since a fixed allocation for life, with a preponderance of equities, has a survival rate of 100%, for all early and normal retirements (before age 70).

Finally, let's say you're a stubborn Boglehead (if I dare make the pun) and you want to follow the "age=obligation" rule at all costs. The only way to ensure total capital survival is to further reduce the withdrawal rate (which has already been set very conservatively).

Let's take the example of a 65-year-old, recently retired, who needs 50,000 francs a year to live. In accordance with the famous rule, his portfolio contains 65% of bonds. To achieve 100% of capital survival, the withdrawal rate must be reduced to 3.5%. This means that his initial capital must amount to 1,428,571 bales. With a 70/30 portfolio, his withdrawal rate would be 4.1%, i.e. an initial capital requirement of "only" 1,219,512 bales. His "age=obligations" retirement therefore costs him 209,059 francs more. In addition (and above all), you have to add to this amount the cumulative negative returns due to his approach during the capital accumulation phase, compared to a strategy with a high equity component. It's hardly surprising, then, that the study we mentioned above claims that this strategy requires 61% more in savings to achieve the same objective.

Morality

Rather than blindly following a rigid, inconsistent and inefficient rule, it's better to stick to a fixed allocation, with a high equity content. In fact, an all-equity portfolio can do the trick. In this case, however, the Sharpe ratio is lower than that of a portfolio with a minority of bonds. Since a better Sharpe ratio implies a better risk-free withdrawal rate, a portfolio with around 75% of equities is preferable (except in the case of very late retirement). By a roundabout way, I arrive at the same conclusions as in my book.

Beyond 60/40

We tested several approaches, varying the weightings of equities and bonds in different ways. We've seen that dynamic allocation and age allocation don't add any value to a simple static allocation - quite the contrary. In fact, of all our backtests, the most conclusive were those in which we played with asset subclasses rather than weightings.

To go even further, we need to look outside the system for the solution. 60/40 works well because it combines two assets with zero or even negative correlation. In our real estate articlewe have seen that thereal estate Swiss equities also had a low correlation with equities. That's good news, because it also has a low correlation with bonds. A very interesting candidate for diversifying a 60/40 portfolio.

If we take our best portfolio (association of the triad of equity ETFs with CSGC0) and add Swiss real estate, with the SRFCHA ETF, we get even better results. The backtests below go back to 2011, the limit being set by SRFCHA. I took the opportunity to test a few portfolios with TLT as well, given its interesting potential over the longer term.

Findings

• The best portfolio tested so far, comprising the triad of ETFs at 60% with CSBGC0's 40%, finishes at the back of the pack.
• Conversely, in first place, surprisingly, we find one of the best PFs tested in the last article in this series. It involves no bonds at all, since these are entirely replaced by real estate. It is therefore an unconventional form of 60/40. As far as results are concerned, however, beware. The backtest period is relatively short. There was no major bear market, and the very low, zero or even negative interest rates prevailing since 2008 have blown real estate to the detriment of bonds. It's certainly a good strategy, but first place may be usurped, at least over the longer term.
• In terms of Sharpe ratio and CAGR, the difference in results is minimal between strategies allocating 40% to real estate, 30% to real estate and 10% to bonds or 20/20.
• Splitting the bonds in two (TLT+CSBGC0) gives slightly better results for CAGR, with a more or less identical Sharpe ratio. Here too, however, the difference remains minimal compared to CSBGC0 alone.

Reflection: two possible points of view

1) Bonds have been underperforming since the 2008 financial crisis, due to the extremely accommodating policies of central banks. Over such a long period of time, this is not a cyclical but a structural cause, rather like the one that has seen gold soar since the early 1970s following the abandonment of the gold standard. Bonds will never again perform as well as they did before the 2000s. Central banks, scalded by 2008, will facilitate credit as often as possible, even if it means causing a little inflation. They will raise rates if necessary, at the very least, and lower them as quickly as possible. Anemic growth due to an ageing population will allow them to do so. In this case, it's best to leave bonds behind and focus on real estate.

2) The cause is not structural, but cyclical, even if the effects are felt over several decades. It is caused by two successive violent crises on the stock markets (2000 and 2008), which drove interest rates so low that unconventional expansionary policies had to be implemented over the long term. In 2020, we thus found ourselves in a situation similar to that of the 1940sThis was followed by a very long phase of rising interest rates and growth. This was followed by a very long phase of rising rates and growth (Trente Glorieuses), which was largely favorable to equities. Bond performance remained fairly modest until the early 1980s.. This was due to relatively low interest rates, especially until the late 1960s. It was also due to the rate hikes themselves, which drove bond prices down. In the early 1980s, on the other hand, the timing was perfect: rates were at their highest, offering very generous coupons. What's more, as they began to decline, bond prices climbed at the same time. If things were to go back to the way they were, we'd be looking at 40 years of bond underperformance. That's no mean feat on an individual scale. But there's no guarantee that it will last that long. It could be longer, because we're starting from even lower rates. But it could be shorter because rates have risen much faster. Today, we're at a rate similar to the 1960s. So we've gained 20 years in five, if I dare make the comparison. Rates are not yet attractive, but they are more reasonable than what we've seen since 2008. What's more, rates aren't everything. The other advantage of bonds remains their low correlation (most of the time) with equities. Mixing bonds and real estate therefore seems a pragmatic approach.

Morality

Since we can't know what the future will bring, a reasonable strategy is to mix, in addition to the 60% in equities, 20% SRFCHA, 10% TLT and 10% CSBGC0, which ensures diversification across asset classes and sub-classes. Even over the last 13 years, this strategy is only slightly worse than the best in terms of CAGR and Sharpe. Over the longer term, there's a good chance it will even win.

Conclusion

In this detailed analysis, we examine the evolution of the 60/40 strategy from its beginnings as a fundamental contribution by pioneers Benjamin Graham, Harry Markowitz and William Sharpe. Although it has long prevailed as the norm, contemporary economic changes, marked by low interest rates and erratic correlations between stocks and bonds, are now calling its relevance into question.

We discussed alternatives such as 70/30 and 50/50 portfolios, which offer a different balance between growth and defense. We pointed out that 60/40 is behind many trendy new portfolios under different names. We have also seen that dynamic allocation strategies, or those that adapt to the age of the investor, leave much to be desired. On the other hand, we have shown the importance of judicious selection of asset sub-classes. We have also suggested ways of going beyond a 60/40 portfolio, by adding other assets, in particular real estate.

As we have seen, the optimum share of equities in a portfolio is :

• Sharpe ratio: between 50% and 70% depending on risk appetite
• from a capital survival rate point of view, with retirement before age 70: between 75% and 100%, depending on risk propensity, ideally 75% from a Sharpe ratio point of view

Putting all this together, we can establish a sweet spot of around 70%-75% in equities, which can serve as a benchmark for building individualized portfolios, depending on personal situation and risk appetite. In "Stocks for the Long Run", J. Siegel arrives at the ideal rate of 68% of shares for a 30-year investment period. So we're right on target. As for the legendary B. Graham writes in "The Smart Investor"In fact, we've always said that a portfolio should never have less than 25 % or more than 75 % of its funds in common stocks. This puts us at the upper end of this very wide range.

An optimized 60/40 portfolio, comprising the triad of ETFs, 20% of bonds (CSBGC0 with or without TLT) and 20% of SRFCHA, should also do the trick. Its excellent results may indeed compensate for its lower equity allocation compared to a basic 70/30 portfolio. Given the lack of historical data for the ETFs concerned, I was unfortunately unable to test the survival rate of this portfolio. However, the results between 2011-2024 speak in favor of the optimized 60/40 portfolio over a basic 70/30 strategy:

• SPY 70% + TLT 30% : CAGR = 10.85% / Sharpe ratio = 0.95
• Triad 60% + 20% CSBGC0 + 20% SRFCHA : CAGR = 9.99% / Sharpe ratio 1.1

A higher Sharpe ratio means that, at equal risk, the optimized 60/40 portfolio outperforms the basic 70/30 strategy. It also means that the potential withdrawal rate is higher or, if the withdrawal rate remains the same, that the portfolio's survival rate is higher.

To get an idea of the figures, I backtested a variant of the optimized 60/40, using TLT instead of CSBGC0 and VNQ (US real estate) instead of SRFCHA. By doing so, I obtain an average survival rate (retirement at 45, 50, 55, 60 or 65) of 98.7%, which is 97.46% for the classic 60/40 and 99.54% with the 70/30. It's still not perfect, but we have seen in this article, and in the one devoted to real estate, that SRFCHA and CSBGC0 produce portfolios with better Sharpe ratios than VNQ and TLT. The chances are therefore very high that the optimized 60/40 portfolio will pass the test every time.

Be that as it may, what's important is that the 60/40, initiated 75 years ago by the aforementioned legends, is still an excellent way to aim for profitability while protecting yourself from risk. By remaining within the general framework of this typical allocation, it is possible to optimize it by adjusting the planned weightings slightly, and above all to play with the sub-asset classes, or even to complement it with other asset classes.

The approach must remain flexible and personalized, enabling investors to successfully navigate the financial landscape. This underlines the importance of diversification and regular assessment of asset allocation to ensure that it meets the unique needs and aspirations of each individual.