What Is a 60/40 Split in an Investment Portfolio?

The 60/40 split represents a widely recognized strategy in investment portfolios. This approach involves allocating investments to different asset types to achieve a balance between potential returns and risk exposure. It serves as a foundational concept for investors aiming to construct a diversified portfolio, helping them navigate market fluctuations. Many investors consider this allocation a starting point for their financial planning.

Understanding the Components

The “60” in a 60/40 portfolio refers to equities (stocks), while the “40” represents fixed income assets (bonds). Equities signify ownership shares in a company. When an investor buys stock, they acquire a small piece of that company, and if the company performs well, the value of its stock can increase, leading to capital appreciation. Stocks also offer income through dividends, which are company profits distributed to shareholders.

Bonds, on the other hand, represent a loan made by an investor to a government, corporation, or other entity. When you purchase a bond, you are lending money to the issuer, who agrees to pay regular interest payments over a set period. At the bond’s maturity date, your initial investment, known as the principal, is returned. Bonds are generally considered less risky than stocks and provide a more stable income stream, though their potential for capital appreciation is lower.

The Investment Philosophy

The 60/40 allocation centers on diversification and risk management. This balance aims to combine the growth potential of stocks with the stability and income generation of bonds. Stocks historically offer higher potential returns over the long term but come with greater volatility and risk of capital loss. Bonds tend to be less volatile, offering a cushion during stock market downturns and a consistent source of income.

This combination mitigates overall portfolio volatility. When stock markets experience declines, the bond portion of the portfolio may hold its value or even increase, offsetting some of the losses from equities. Conversely, during periods of strong economic growth, stocks drive portfolio gains, while bonds continue to provide a steady income stream. The 60/40 split, therefore, acts as a general framework to balance the pursuit of growth with the need for portfolio stability.

Portfolio Management

Maintaining a 60/40 investment split over time involves rebalancing. Market movements can cause the initial 60% stock and 40% bond allocation to drift from its target. For instance, if stocks perform exceptionally well, their percentage of the portfolio might increase, while bonds shrink proportionally. This shift can expose the portfolio to more risk than originally intended, as the equity portion would now dominate.

Rebalancing adjusts the portfolio back to its desired allocation by selling assets that have outperformed and using those proceeds to purchase assets that have underperformed. For example, an investor might sell stocks to bring their allocation back to 60% and buy bonds to restore their 40% share. This process ensures the portfolio’s risk and return characteristics remain aligned with the initial strategy. Rebalancing can be performed at fixed time intervals, such as annually or semi-annually, or when an asset class deviates by a certain percentage from its target allocation.