Rising interest rates are once again fueling calls to revise the classic 60/40 portfolio of US stocks and bonds. For decades, investors have relied on bonds not to maximize returns, but to help manage risk and help them stay invested when stocks tumble. Yet the correlation between stocks and bonds remains higher than before 2022, reviving a familiar argument: If bonds no longer reliably zig when stocks zag, perhaps the traditional balanced portfolio no longer works.
But that conclusion rests on a simplistic reading of a single statistic. Correlation describes whether two assets tend to move in the same direction, but it says nothing about the size of those moves or whether they help or hurt investors. Stocks and bonds can be positively correlated because they are both rising (good news) or because they are both falling (bad news).
The 60/40 portfolio was never designed around the idea that bonds would offset every stock market decline. Its purpose is to combine two assets with different risk characteristics to create a smoother investment experience. The objective of diversification isn’t to avoid periodic losses. Those are an unavoidable part of investing. The real goal is to reduce the severity of those short-term losses so investors can remain committed to their long-term plan through difficult markets.
Recent years have been more challenging for the 60/40 portfolio, but it’s not because diversification has failed. One reason stocks and bonds are more correlated is that they have been moving in the same direction more frequently: both during months when stocks are losing money and making money.
Stocks and bonds have lost money together in about 14% of months over the past 25 years. That climbed to 28% over the past five years, reflecting 2022’s inflation-driven selloff, when aggressive Fed rate hikes battered both asset classes. Although higher interest rates and inflation have proved sticky, simultaneous stock and bond declines have become less frequent, occurring in 22% of months over the past three years.
At the same time, stocks and bonds have been rising together more often. Over the past three years, both asset classes rose in 50% of months, up from 43% over the past five years and 40% over the past 25 years.
These figures show why correlation doesn’t tell the whole story. A higher correlation means stocks and bonds have been moving in the same direction more often. It doesn’t tell investors how big those moves were or whether bonds still helped smooth the ride.
Bonds Still Provide a Volatility Buffer
Looking at how bonds behave during the stock market’s worst months provides a better measure of whether bonds are still serving their intended role.
The chart below examines the market’s worst 10% of months across several periods. Bonds have provided less downside protection over the past three years than they did over the previous 25 years, reflecting the inflationary headwinds. Yet bonds have continued to lose far less than stocks during the market’s most difficult periods.
Over the past three years, when stocks fell nearly 5% on average during their worst months, core bonds declined about 1.7%, roughly one-third as much. That cushion is smaller than investors experienced over longer periods, when bonds often held their value or even gained during equity selloffs, but it remains a meaningful reduction in portfolio risk.
That difference matters more than just reducing losses. It also creates rebalancing opportunities. Consider a $100,000 60/40 portfolio. During one of the market’s worst months over the past three years, the stock allocation would have fallen to about $57,000 from $60,000, while the bond allocation would decline to roughly $39,300 from $40,000. Because bonds held up better, they would represent about 41% of the portfolio, slightly larger than the 40% target. Rebalancing would involve selling about $900 of bonds and buying stocks to get the stock portfolio back to 60%. That option to rebalance positions the portfolio to benefit when markets eventually recover.
The opportunity is smaller than it would have been in periods when bonds rose as stocks fell, but the principle is the same. Bonds don’t have to post positive returns during every equity selloff to add value. They simply need to lose less than stocks, cushioning the overall portfolio while providing capital to systematically buy equities after they have become cheaper.
Bonds Still Play a Key Role in the 60/40 Even When Correlations Are Higher
If inflation remains higher, bonds may not always provide the same level of downside protection they have in the past. Fixed income’s portfolio role, however, has never depended on going up every time stocks go down. They can stabilize the still-riskier stock portion of a 60/40 portfolio by falling less and providing rebalancing fuel.
The goal of owning bonds has never been to prevent losses. It has been to make those losses more manageable. Investors don’t lose sleep over correlation figures—they fret over the risk of watching their portfolios drop by 20% or more. By reducing losses and creating rebalancing opportunities, bonds help investors stick with their long-term plans, which improves their chances of achieving their goals.
