The famed 60:40 asset allocation strategy put to the test. Is it for you?

Many of the market veterans talk about adopting a 60:40 strategy for your portfolio. I have decided to put it to test on the basis of the past 10 years of data (1 April 2009 to 31 March 2019). In fact, I have gone a step further and improved it, as I will explain below. I will also suggest who should opt for this strategy.

What is the 60:40 strategy?

60:40 strategy advocates that an investor invest 60% of his portfolio into equities and 40% into debt. This is a passive style of investing with regular re-alignment to the predetermined 60:40 allocation ratios.

There is a negative correlation between debt and equity. When equity returns fall, debt returns rise and vice versa. Thus, having a debt component cushions the returns during a stock market crash.

How does this strategy help?

This strategy is good for most investors, who can't handle the extreme volatility that equities go through. Statistically speaking,

• Most equity investors enter the market near the peaks driven by the euphoric conditions and extrapolation of the glorious past returns
• Most equity investors think that they will weather the volatility and be invested for the long term to reap the benefit of equity, but they eventually don't.
• Most investors exit the market near the bottom driven by negative news coverage and scare of a further meltdown.

All of these factors adversely affect the returns. In one of my previous articles, "Is a market crash near?", I had shown that when investors invested near peaks with Nifty PE above 26, even their 5-year rolling returns were negative!

Since this flawed decision making is driven by emotions, this strategy, in turn, takes emotions out of the picture. Equity and debt allocations are re-aligned mechanically as per the predetermined allocation strategy.

My tweaks to this strategy

To improve this strategy further, I have made the following tweaks:

• The asset allocation of 60:40 has been divided as below:

• The breakup of 60:40 is done such that investor may reap the benefit of rise in Large, Mid and Small Cap while reducing the risk of high exposure to any one
• The 10% liquid fund allocation is a form of an emergency fund which can be useful in times of need
• In my analysis, the portfolio has been realigned every six months (March and September end). Alternatively, it may be realigned once a year.
• Also, considering that Indian equity markets don't follow the efficient market hypothesis (i.e. everything is in the price), our fund managers have delivered an alpha (additional return) over the index returns. So for the analysis, amounts have been invested in indicative MFs instead of market indices.

The Results

This chart represents the 10-year cumulative returns of Equities, Debt and the 60:40 portfolio.

This chart shows how equity markets have outperformed debt since March 2009.

However, looking at this chart, some may conclude it is best to stay invested in equity 100% since the absolute returns are always above the debt returns. This conclusion would be skewed due to the period under consideration.

• March 09: Market was near the bottom after the 2008 market crash. Since this is the starting time of our 10-year study, investing at the bottom means the equity returns are higher than average.
• March 19: Market was near its all-time high. The equity returns, therefore, are higher than normal.

So as to not be misguided by the conclusions drawn from the above 10 year period, I have analyzed a separate market period (September 2010 to September 2016)

• September 2010: This is the time after markets had reverted back from the market crash. It is near the time when more and more investors were re-entering the markets
• September 2016: This is just before demonetization hit the market. In a knee jerk reaction, a lot of market participants exited the market. The fall of the market is not captured in this period.

The above chart is more depictive of what the average investor faces. Entering during euphoric equity phases (which most investors do) results in depressed returns during the initial years. As we can see, absolute equity returns are negative for the first 2 years and then near 0 for the 3rd year. The average investor exits if his 3-year returns are near 0. It is only in the 4th year that equity returns cross debt returns.

The 60:40 strategy is thus helpful. It helps investors tide over tough times to be able to enjoy the benefit of equity in the long term.

Conclusion

For investors who don't have the time to follow the market and are moderate risk takers, such strategy is wonderful. Portfolio realignment is a simple task to be done only 2 times/ once a year.

This strategy helps investors tide over the short term turbulence to be able to enjoy the long term benefits.

This strategy has given CAGR returns of 16.6% for the 10 year period (cumulative returns 363%). Even for the 6 year period (Sep 10- Sep16), the CAGR returns are 12.3% (cumulative returns 101%). These are phenomenal returns by any measure.

Note: This strategy is not for the following people:

• Conservative investors who can't afford any drawdown in the principal even for a short while.
• Investors with a short term horizon < 3 years.

I hope this helps you, my reader. If you have doubts, feel free to comment. I will do my best to answer your queries. You may also be interested in my other recent articles as listed below:

• Is a market crash near?
• Same SIPs. Better Returns! (It's not just about Direct Funds)
• Real Estate in Mumbai
• 600% in 6 years! The strategy that gave 6x the market returns explained!