Stocks vs. Bonds and the 60/40 Rule

While a diversified portfolio is key to achieving consistent long-term portfolio growth, every investor has a slightly different approach to asset allocation. In this segment of Backstage Pass, recorded on Nov. 17, Fool contributors Connor Allen, Rachel Warren, and Travis Hoium discuss stock vs. bond investing and the 60/40 rule. 

Connor Allen: What people don't realize is that the interest rates can actually go down still. Even though they are at like 1.9% for the 30-year treasury bond right now, they can still go down. They can even go negative. We've seen over in Japan, they've had basically zero interest rates for a very long time. That could happen in the U.S., but that happens for a variety of reasons in Japan, including the fact that most of their population are savers.

They save a lot of their money, they don't spend a lot of it. That keeps interest rates are very low over in Japan. I don't think the U.S. is built that way. I think over here, people love to spend money. I don't think we're going to see that same thing that happened in Japan.

But if you are investing in bonds, I just want to say one thing and that's make sure that if you're investing in bond funds, make sure that the fund manager is somebody that you trust. Look into their backgrounds, see what their performance is like, and make sure that they're not selling out of bonds too soon.

Letting some go all the way to expiration and get that payout because I think a lot of times right now, if interest rates go up, then those bond prices could go down. But if you just hold it all the way, you'll get that payout at the end. Maybe you should hold bonds yourself or maybe just find a bond fund manager that you really trust.

Rachel Warren: Excellent. I don't think the 60/40 rule is dead either. I think it makes sense for a lot of people. I also think it depends what point you're at perhaps in your investing journey, the kinds of investments that perhaps you are comfortable with at say 20 were probably very different than what you might want to hold in your portfolio at 50 or at least perhaps more diverse collection of companies. 

The riskier ones balanced by a broader collection of some of those portfolio stalwarts. But I say this also as someone who is a 100% invested in stocks. For me as a newer investor, that has been where I have focused my efforts.

I think there are many, many ways to diversify one's portfolio and I think it very much comes down to your personal risk tolerance. I think it comes down to your personal investing goals and your personal financial goals. For me, something I have done is I have picked industries that I know well that I study a lot.

Healthcare, e-commerce, and tech are my heaviest concentrations in my portfolio and those are areas I plan on continuing to build upon and to hold for a really long time. For example, one company that I love and I plan on holding basically forever is Johnson & Johnson.

They're a healthcare company that's been around for well over a century. They've been solidly increasing their dividend every year for, I believe, at or perhaps more than six decades. They're not going anywhere.

That's a stock that is not going to have these insane portfolio returns overnight, but it is the kind of stock you can buy and hold for many decades. Do you have thoughts on this Travis?

Travis Hoium: Yeah, one thing I wanted to talk about and you both touched on this, but one of the risks with bonds that I think some of these advisors might be seeing is what's known as duration. That just simply is, if you have a 10-year bond and interest rates go down, the value of the bond goes up.

As Connor said, if you hold it for the entire life of the bond, that may not matter. You're just looking at the volatility of the asset on an ongoing basis. But this is the U.S. treasury rate, 10-year rate since 1980. You can see that rates have been going down consistently for over 40 years now. There is a zero there. [laughs]

I maintain that rates could go negative but I don't think that's really a great reason to buy bonds that you are betting that rates are going to go negative. If rates do go up and you're holding a 10-year or a 30-year, or a 50-year bond, the value can go down pretty dramatically.

I think one of the arguments there is, yes, a stock like, let's say, Verizon that I picked, that could also go down. But if interest rates go up and both of those assets go down, you didn't take any risk off the table by owning the bond. I think that's the argument that some of these maybe the flip against 60-40 is making. One thing I would say is if you do own bonds, or you own bond funds specifically, know what those rules are.

Sometimes bond funds will buy an asset at a certain duration and sell it at another duration. Understanding what the dynamic is in that fund is really important. Sometimes there's also assets that will just hold them until they're mature. Worth understanding what the nuances are, whether you're investing directly in a bond or are you using funds to do that, because those nuances can be really key.