For decades, Wall Street has advocated the “60/40” rule—investing 60% in stocks and 40% in bonds. This strategy aims to balance risk and reward, especially for retirees. However, experts are rethinking the need for bonds in the portfolios of Millennials and Gen Z.
The Traditional 60/40 Strategy: Outdated for Younger Investors?
The 60/40 portfolio is popular because it reduces risk. Bonds provide stability, cushioning against stock market volatility. However, younger investors may not benefit as much from this conservative approach.
Trent Smalley, a Chartered Market Technician and portfolio manager at JSPM, suggests that young investors don’t need bonds unless they struggle with market volatility. “Bonds reduce a portfolio’s volatility, but for younger investors, that’s less important,” Smalley said on Yahoo Finance’s Stocks in Translation podcast.
Stocks Offer More Growth Than Bonds
Historically, stocks have outperformed bonds. From 1993 to 2023, the S&P 500 had a compound annual growth rate (CAGR) of 7.8%. When dividends were reinvested, that figure jumped to 9.9%. Meanwhile, the Bloomberg US Aggregate Bond Index only saw a CAGR of 3.3%.
This makes stocks more attractive for younger investors. Millennials and Gen Z can take advantage of stock market growth because they have a longer time horizon. They can afford to weather market fluctuations and still come out ahead.
Volatility Can Be an Opportunity for Young Investors
Market volatility can make investors uneasy, especially during downturns like 2022 when the market dropped by 20%. However, younger investors can benefit from these dips. With regular contributions through dollar-cost averaging—investing a fixed amount at set intervals—investors buy more stocks when prices are low. Over time, this approach leads to higher returns.
Bonds and Stocks Are Becoming Correlated
Bonds traditionally offset stock market risk by moving inversely. However, since 2021, bonds and stocks have become more correlated, rising and falling together. In 2022, both had one of their worst years, causing 60/40 portfolios to suffer significant losses.
This increasing correlation has weakened the diversification benefits that bonds once provided.
Bonds Underperform During High Inflation
Bonds also struggle during periods of high inflation and rising interest rates. In today’s environment, these factors have reduced bond yields, limiting their ability to provide stability. With inflation eroding bond returns, younger investors may want to rethink the role of bonds in their portfolios.
A Better Investment Strategy for Millennials and Gen Z
Younger investors should focus on dollar-cost averaging into low-cost index funds. Smalley calls this approach foolproof for building wealth over time. Index funds offer diversification within the stock market, and with time on their side, Millennials and Gen Z can ride out downturns while capitalizing on long-term growth.
Relying too much on bonds may hinder wealth-building potential. Bonds have shown lower returns and less stability in recent years.
Conclusion: Reconsider the Role of Bonds
Bonds may still be useful for older or more conservative investors. However, Millennials and Gen Z can take on more risk and focus on stocks for higher growth. Dollar-cost averaging and stock-heavy portfolios provide greater potential for long-term wealth.
By rethinking the role of bonds, younger investors can maximize returns and avoid the limitations bonds currently face.
