Executive Summary
The 60/40 portfolio—60% stocks, 40% bonds—was the default allocation for balanced investors for decades. It offered diversification, reasonable returns, and downside protection.
Then 2022 happened. Stocks fell 18%. Bonds fell 13%. The negative correlation that made 60/40 work broke down completely.
Was this a temporary anomaly or a permanent regime change?
What Killed 60/40?
The culprit: synchronized inflation shock. When inflation surges, both stocks and bonds fall together because:
- Bonds fall as yields rise to compensate for inflation
- Stocks fall as profit margins compress and discount rates increase
This happened in the 1970s and again in 2022. The correlation between stocks and bonds flipped from -0.3 to +0.5.
Can It Be Fixed?
Yes, but it requires modifications:
60/40 2.0:
- 50% equities (quality bias, lower duration)
- 30% short-duration bonds (1-5 years)
- 10% inflation hedges (TIPS, commodities, gold)
- 10% alternatives (real estate, private credit)
The key insight: duration matters. Long-duration assets (growth stocks, long bonds) are vulnerable to inflation shocks. Shorter duration assets provide better protection.
Historical Context
The 60/40 portfolio worked brilliantly from 1980-2020 because:
- Inflation fell from 14% to 2% (bond bull market)
- Interest rates fell from 15% to 0% (multiple expansion)
- Globalization suppressed costs (profit margin expansion)
None of these tailwinds exist today. We're in a higher-rate, higher-inflation regime that requires different portfolio construction.
The New Allocation
Our recommended balanced portfolio for 2025:
- 45% equities (overweight value, quality, international)
- 25% investment-grade bonds (5-7 year duration)
- 15% real assets (commodities, infrastructure, real estate)
- 10% cash/T-bills (optionality for opportunities)
- 5% alternatives (gold, hedge funds, private credit)
This allocation targets 7-9% returns with lower drawdowns than traditional 60/40.
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