“Higher interest rates are here to stay.”

So declared Vanguard, staid bastion of relative sanity where I’ve always parked a considerable sum of my own money. There’s something oddly comforting about a firm that still requires some documents be hand-signed (with an actual ink pen) and hand-delivered (via physical mail).

Normally, I wouldn’t mention a year-ahead piece from Vanguard, but their 2024 outlook was notable for what the firm said about the epochal shift away from the easy money era and the prospects for 60/40 funds, something Vanguard knows a thing or two about.

After declaring, exclamation point and all, that “Bonds are back!” Vanguard called the case for 60/40 portfolios “stronger than in recent memory.” As most readers are no doubt aware, it’s been a rough ride for multi-asset investors, and particularly for 60/40 allocations which suffered mightily when bonds not only ceased to hedge equity losses, but in fact became the bane of stocks’ existence.

Recall that at one point last month, the world’s largest Treasury ETF was the most volatile ever relative to the S&P.

You know the story. Hopefully you can recite some version of it from memory. I’ll recycle some familiar language. An entire generation of investors was raised to believe the 60/40 split was a guaranteed path to reliably positive, diversified returns with relatively low volatility. That was true right up until it wasn’t. It was based on the assumption that the negative stock-bond return correlation which persisted for two decades (give or take) would persist in perpetuity. The risk was always inflation: A bout of unstable prices had the potential to end the four-decade bond bull and central banks’ efforts to slay the inflation dragon could reset equity valuations, resulting in a simultaneous selloff — a positive stock-bond return correlation.

That’s precisely what happened in 2022, and as I’m always keen to point out: The correlation assumption behind the idea that 60/40 portfolios were as close to infallible as investment strategies can be was a product of recency bias — the same recency bias that said The Great Moderation was the new normal and that the age of great power struggles and ideological clashes was over. We were lulled to sleep.

For illustrative purposes, note that a 50/50 portfolio of the S&P 500 (total return) and 20-year+ US Treasurys suffered a 28% drawdown from December of 2021 through October of 2022.

The good news is that the selloff resulted in a more attractive starting valuation for balanced portfolios thanks in no small part to cheaper bonds. The bad news (from the perspective of anyone looking for a cheap entry point) is that 2023’s equity rally on the back of A.I. optimism means stocks are still expensive.

If that language sounds familiar, that’s because I pulled it directly from an article published here last month, when I documented a somewhat cautious take from Goldman, whose Christian Mueller-Glissmann suggested there’s still some risk of a so-called “lost decade” for 60/40 portfolios.

Vanguard sees things a little differently. “Long-term investors in balanced portfolios have seen a dramatic rise in the probability of achieving a 10-year annualized return of at least 7%, the post-1990 average,” the firm said this week.

Specifically, the odds of matching the three-decade average 10-year annualized return were just 8% in 2021, during peak “everything bubble.” Now, those odds are 40%, a remarkable about-face attributable (obviously) to higher yields, which Vanguard suggested may be the best thing that’s ever happened to young investors with a long-term investment horizon.

“Despite the potential for near-term volatility, we believe [the] rise in interest rates is the single best economic and financial development in 20 years for long-term investors. Our bond return expectations have increased substantially,” the firm said.

As for the sea change that brought an end to the easy money era, Vanguard suggested it was overdue and welcome. “This development ushers in a return to sound money, and the implications for the global economy and financial markets will be profound,” the outlook declared. “Borrowing and savings behavior will reset, capital will be allocated more judiciously and asset class return expectations will be recalibrated.”

That may sound scary to some younger investors still struggling to come to terms with price discovery and the idea that if you want other people to finance your purchases and investments, you have to pay them for that service, but as Vanguard put it, a “higher interest rate environment will serve investors well in achieving their long-term financial goals,” even if, in the near-term, “the transition may be bumpy.”