Bank of America warns that the time-tested 60/40 portfolio strategy is on its deathbed — but you can still profit by making these 11 investments

  • The 60/40 portfolio doesn’t work anymore, according to Bank of America.
  • Bonds don’t provide the returns or diversification benefits that popularized the strategy.
  • Here are 11 types of investments to consider instead for both returns and income.

For decades, a portfolio made up of 60% stocks and 40% bonds delivered solid returns while reducing risk through diversification.

But Bank of America now believes following the once-foolproof 60/40 strategy is a fool’s errand.

“We see more evidence than ever that conventional model portfolios like 60/40 are ill-prepared for the macroeconomic shift from a ‘2%’ to a ‘5%’ world of structurally higher inflation, interest rates, and volatility,” wrote Jared Woodard, the head of Bank of America’s research investment committee, in a mid-June note.

A spike in interest rates and inflation in 2022 led to one of the worst years ever for the 60/40 strategy. Stocks and bonds both got crushed as the S&P 500 lost 18% after dividends, while long-term US Treasuries declined by 31%.

If the 60/40 portfolio was on life support last year, this year its demise is now “confirmed,” Woodard wrote.

His reasoning is simple: traditional bonds aren’t holding up their end of the bargain anymore, as they no longer offer sufficient returns or proper diversification.

Bonds require 40% of the assets in a 60/40 portfolio but have delivered only 25% of the returns since 1920, he noted. And when stocks and bonds both thrive, the latter adds little to returns.

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And recently, bond benchmarks have been increasingly correlated with stocks, Woodard noted. He added that the insurance that bonds should provide for a portfolio isn’t paying off either.

“Investors holding Treasury bonds as an insurance policy have overpaid for protection,” Woodard wrote.

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The downside protection that bonds are supposed to provide appears to be over-exaggerated. Fixed income is more volatile than many realize, as the research head noted that bonds have fallen at least 25% twice in the last 20 years. That includes 2022, when long-term bonds gave up eight years of gains in a few short months, according to Woodward.

“Even if the future looks very much like the recent deflationary past, owning Treasuries seems like a poor use of capital,” Woodard wrote. “And in a future of structurally higher inflation and interest rates, the need for better fixed income portfolios will be even more urgent.”

Weak bond returns will lead to “another lost decade” for the 60/40 portfolio, in Woodard’s words. He thinks the strategy will need more than six years just to break even on an inflation-adjusted basis, assuming an average annual gain of 7.5% for stocks and average returns for bonds.

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11 ways to give your portfolio new life

The 60/40 portfolio’s shaky outlook should cause investors to rethink their asset allocation mix, Woodard wrote.

But investors can avoid losing a decade’s worth of returns by seeking alternatives to traditional equities and fixed income, according to Bank of America.

Within stocks, the firm said it prefers exchange-traded funds (ETFs) that track the equal-weight S&P 500 index, small-cap value stocks, quality companies, and natural resources.

This year’s top-heavy market rally is starting to broaden out, which Bank of America believes will benefit the smaller stocks in the S&P 500. The index trades at 20x forward earnings, though that falls to just 15x when the 50 largest companies by market capitalization are excluded.

If breadth keeps improving, two ETFs to consider that Bank of America listed are the Invesco S&P 500 Equal Weight ETF (RSP) and Vanguard Small-Cap Value Index Fund ETF (VBR).

Other ETFs the firm likes include the Pacer US Cash Cows 100 ETF (COWZ) for quality, given its high free cash flow yield, and funds tied to natural resources like the Energy Select Sector SPDR Fund (XLE), the SPDR S&P Metals & Mining ETF (XME), and the Global X Uranium ETF (URA) for exposure to oil, precious metals, and uranium, respectively.

For income, Bank of America’s researchers unveiled a strategy called “dynamic prudent yield” that promises to beat bond indexes while carrying less risk. This includes buying fallen angel corporate bonds, debt from emerging markets, high-yield US municipal bonds, leveraged loans, convertible bonds, and preferred stock. Cash alternatives are also worth owning.

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“BofA Research expects US economic growth to slow, so we still favor high-yielding fixed income sectors vs. equities in our asset allocation,” Woodard wrote.

Bank of America favors the following high-yield bond ETFs: the VanEck Fallen Angel High Yield Bond ETF (ANGL), the Vanguard EM Government Bond ETF (VWOB), the First Trust Municipal High Income ETF (FMHI), the iShares National Muni Bond ETF (MUB), and the VanEck High Yield Muni ETF (HYD).

For leveraged loans, investors can consider the SPDR Blackstone Senior Loan ETF (SRLN). As for convertibles, options that Bank of America highlighted for high-growth yield include the iShares Convertible Bond ETF (ICVT) and the SPDR Bloomberg Convertible Securities ETF (CWB). Convertible bonds are often issued by smaller, fast-growing companies that are rebounding this year, the note read, plus they’re less rate-sensitive than other coupons.

Income can also come from preferred shares of companies. In fact, Woodard noted that preferred stock ETFs like the Global X US Preferred ETF (PFFD), iShares Preferred and Income Securities ETF (PFF), and the VanEck Preferred Securities ex Financials ETF (PFXF) can offer better payments than high-yield corporate bonds.

Lastly, cash alternatives like the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL), the iShares 20+ Year Treasury Bond ETF (TLT), and the Schwab Intermediate-Term US Treasury ETF (SCHR) offer higher-than-normal yields plus flexibility. Flows to Treasury-heavy ETFs have doubled from their early 2021 trough as investors get defensive during economic uncertainty, Woodard noted.