The death of the 60/40 portfolio has been greatly exaggerated.

Ask your search engine, “Is the 60/40 portfolio dead?” and it will generate about half a million results, many of them published recently. Following a difficult year for both stocks and bonds, the increased interest is understandable.

The 60/40 portfolio — shorthand for a diversified portfolio built with 60% equities and 40% fixed income — is intended to generate solid returns while minimizing risk. This did not happen in 2022, as stocks and bonds declined in tandem.

Investors expressed their disappointment with their dollars, withdrawing $43.6 billion from strategies in Morningstar’s “Allocation — 50% to 70% Equity” category in 2022. That followed a period when investors withdrew billions from such strategies in six of seven years for different reasons, including when stock markets were soaring.

“We saw a lot of folks exit balanced strategies in 2022,” says Hilda Applbaum, an equity portfolio manager for American Balanced Fund®. “While there is a lot of wisdom in markets, there also is a herd mentality. I believe many investors have become disbelievers in balanced strategies at the wrong time. I am confident that, going forward, balanced portfolios — whether they are a 60/40 split or 65/35 — may continue to be a successful approach for most investors over the long term.”

Below, Applebaum, who invests in both stocks and bonds, and David Hoag, a fixed income portfolio manager with The Bond Fund of America®, share three reasons they believe conditions today are more favorable for balanced investing, as well as perspective on how they see balanced approaches evolving.

Reason #1: 2022 was an anomaly, not the norm

Last year stands out as the only time in the past 45 years that both stocks and bonds declined in tandem for a full calendar year. “The culprit for the chaos in both stocks and bonds last year was the Fed’s aggressive rate hikes,” Hoag says. “I think it’s very reasonable to say that bonds will go back to offering diversification benefits as we near the end of the tightening cycle.”

Applbaum says such correlation between the two asset classes won’t likely repeat soon. “With stocks and bonds correlated in terms of their returns, I believe last year reflected an inflection point, not a new normal,” she says.

Once the Fed gets inflation under reasonable control, it will have more flexibility, and investors can likely expect bond markets to zig when stock markets zag.

Reason #2: Attractive income is back in fixed income

If there’s a silver lining to the aggressive Fed action, it’s that most classes of bonds are offering significantly higher yields than a year ago. The yield on the Bloomberg U.S. Aggregate Index, a widely used benchmark for investment-grade (BBB/Baa and above) bond markets, was 4.25% as of January 25, 2022. That compares to 1.75% on December 31, 2021. The yields for the Bloomberg U.S. Corporate Investment Grade Index and Bloomberg U.S. Corporate High Yield Index stood at 4.96% and 8.16%, respectively, on January 25.

Dating back to the 2008–2009 global financial crisis, historically low rates meant that investors were not able to count on bonds to make much of a contribution to a portfolio’s total return. But with bonds offering higher potential income today, investors may be able to take less risk with their equity investments and still meet their return expectations.

“Today many core bonds can provide a dependable return in the mid-single digits,” Applbaum says. “And investors who are comfortable taking a little more risk by including some investment-grade and high-yield bonds can look for their bond portfolios to potentially contribute even more to a portfolio’s total return. That means you can take less risk with respect to your allocation to stocks in your pursuit of income and total return.”

Reason #3: Dividends can make a difference

If a bond portfolio can provide mid-single digit returns or better, dividends can potentially contribute to an attractive overall return picture within a portfolio’s equity allocation — without taking undue risk.

Historically, dividend-paying stocks have tended to be less volatile than growth stocks. And although dividends accounted for a slim 16% of total return for the S&P 500 Index in the 2010s, historically they have contributed an average 38% from January 1, 1926, to November 30, 2022. In the inflationary 1970s, they climbed to more than 70%.

“For the first time in a long time, I get to talk about the importance of dividends in terms of shareholder returns,” says Applbaum. “When interest rates were zero, companies really didn't have to think about their cost of capital. They could have lower hurdle rates in terms of returns on investment. Now that capital isn’t free they must be more thoughtful about how they can get the best return on investment, in addition to being thoughtful about when it makes more sense to return money to shareholders in the form of dividends.”

Bottom line: Look for better returns, lower risk in 2023

There are several reasons investors can expect a 60/40 portfolio to deliver better potential returns and lower volatility in 2023 and beyond. Bonds today are offering higher yields than a year ago, and with the Fed taking a less aggressive approach to rate hikes lately, interest rate volatility will likely be more muted. Valuations across a range of stocks are more attractive than they were a year ago as well.

But it is important to remember that there is more to balanced investing than deciding on how much equity and how much fixed income to include in a portfolio. “These aren’t monolithic allocations,” explains Applbaum. “For example, growth stocks and dividend payers offer very different risk-reward profiles. So successful balanced investing depends not simply on how much equity is in a portfolio but also what kind of equity is in a portfolio.”

“Last year many types of asset allocation models failed to deliver on their pursuit of solid returns with moderate risk,” Applbaum adds. “But that followed a long period of relative success. Asset allocation is not a broken or failed strategy. It will always make sense to think about balance, diversification and risk in portfolios. But a one-size-fits-all approach doesn’t work. It’s about building portfolios from the bottom up that align with investor objectives.”