Inflation and the 60/40 portfolio

By Mark Yamada | November 7, 2022 | Last updated on March 19, 2024
3 min read
percentage change / DNY59

This article appears in the November 2022 issue of Advisor’s Edge magazine — our second last print issue. If you’re a print-only subscriber, learn more about our digital transition and how to continue to receive all the best news and features on

The 60/40 portfolio has come under fire in recent years because negative real interest rates dragged performance. But with inflation raging and the policy interest rate now topping 3%, elements of the traditional 60/40 stock/bond asset mix may benefit. The bigger story, however, may be how the end of a 40-year bond bull market could penalize fixed balanced portfolios for the next generation.

Inflation’s impact on long-term investing

That inflation erodes purchasing power is not a surprise, but its devastating impact on capital accumulation may be. When inflation occurs and how it affects markets is important.

Consider the example of Emma and Ahmed. They each saved 9% of their identical salaries annually over 40 working years. Both invested in a balanced fund — 60% in S&P 500 stocks and 40% in 10-year U.S. Treasuries.

The difference? Emma retired at the end of 1981; Ahmed retired at the end of 2021 (see Chart 1). Their 40-year accumulation periods reflect different market environments and returns.

Emma’s 40% bond holdings suffered terribly as interest rates rose from 2.2% to 14.6%. A 40-year bond would have declined from $1,000 to about $138, and Emma was making contributions during the drop. By contrast, Ahmed saw interest rates move from 14.6% to 1.8% by the time he retired: theoretically a 460% increase in price for the same bond. Chart 1, Interest rates and stock prices, January 1941 to December 2021 Click image for full-size chart

The stock market did well over the entire period. Chart 1 shows stock prices on a logarithmic scale to illustrate the rate of gain over the last 80 years. Emma saw stocks increase 12.6 times and Ahmed saw a 34.4-times increase, almost tripling Emma’s gains.

For investors making regular contributions, the sequence of market returns can also make a big difference. While stocks performed well for both our investors, they went sideways during the last third of Emma’s contribution period — when she had the most money invested (highlighted in Chart 1). The last third of Ahmed’s investing period, on the other hand, saw accelerated growth.

Let’s say Ahmed accumulated $500,000 in his four decades of saving for retirement. Emma would have accumulated only $207,641 — roughly two-fifths as much — due to inflation and rising interest rates in the 1970s. That’s a difference between $20,000 and $8,306 in annual retirement income, assuming both Emma and Ahmed spend 4% annually.

The 60/40 portfolio today

People retiring today are likely to experience conditions similar to Emma’s. What does that mean for their investments?

My colleague, Ioulia Tretiakova, ran probabilities for achieving a 70% replacement income — which approximates what is used by defined-benefit pension plans — in falling and rising rate environments. She calculated the probability for a 60/40 balanced fund (rebalanced monthly), a 100% equities portfolio, a 100% bond portfolio and a constant-risk portfolio (assets rebalanced to maintain a constant volatility rather than constant allocation, as a 60/40 portfolio does). Table 1 shows the summary.

Table 1: Probability of 70% replacement income in different markets

60/40 100% stocks 100% bonds Constant risk
Falling interest rates 96% 52% 100% 98%
Rising interest rates 2% 95% 0% 55%
Overall 47% 69% 0% 85%

The 60/40 portfolio was a successful strategy during the past 40 years, but it is a fixed asset allocation that does not perform well when rates are rising. Reconsidering the 60/40 approach may benefit the next generation of investors. Increasing equity exposure comes with much higher volatility, so keeping portfolio risk constant seems to be the best choice.

How to do that? Maintaining constant risk in Canada isn’t simple. S&P has a series of daily risk-control indexes that maintain risk (measured as standard deviation) at levels between five and 15, but there are no products available in Canada yet. Another approach would be to reduce equity exposure when market volatility — as measured by the Cboe volatility index, for example — exceeds 20 for 10 consecutive days. The simplest proxy for Canadians is to use low-volatility ETFs and funds.

Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies.

Mark Yamada headshot

Mark Yamada

Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies.