The investment management industry has gotten lazy. Increasingly, portfolios look the same regardless of which manager you use. They pretty much all have an “all-cap” approach to U.S. stocks, at least a small allocation to international stocks, a bias toward growth to capture the tech rally we’ve enjoyed for most of the past decade, and some bond holdings to hedge the risk of the stock market. The balanced approach of putting 60% in stocks for long-term growth and 40% in bonds for protection still seems ubiquitous, even if the weights vary slightly across investor types.
The traditional 60/40 portfolio has worked quite well in the past, with annualized returns of 9% or more over almost 100 years. That has been enough for retirees to draw 4% of their portfolio annually or for non-profit organizations to meet their usual 5% spending policies, while still covering investment-related fees and staying ahead of inflation. However, things may not be so easy going forward.
Traditional 60/40 Portfolios Are Under Pressure
Even with the recent turbulence for stocks, the overall stock market trades at a very high valuation level. The so-called CAPE ratio remains at the second-highest level, looking back to 1900, just behind the level of the Dot Com Boom. Other periods of high valuation have generally ended badly (the Great Depression, the Nifty Fifty boom and bust, and the Dot Com boom and bust come to mind).
That doesn’t mean a crisis is around the corner – though that can’t be ruled out. What is almost given, however, is that future returns will be lower than what we’ve enjoyed in the recent past. After all, stocks can’t grow to the moon. To expect a 60/40 portfolio to deliver even 7-8% returns in the future is likely unrealistic.
This means that investors need to think differently about the future.
Constructing Custom Portfolios
A well-diversified portfolio can help mitigate risk and protect your retirement income during economic downturns. When building a custom portfolio, it’s essential that it aligns with your personal goals, risk tolerance, and time horizon.
At Armbruster Capital, we take custom portfolio construction from a “mix of stocks and bonds” into something much more diversified to help reduce risk and reach for higher returns in an overall low-return environment. We do this by incorporating:
- Research-backed investment factors into the stock portfolio.
- A broader selection of asset classes (including alternative investments).
- Enhanced diversification using investments with low correlation with one another.
This way, you have a solid chance of taking advantage of strong market runs while safeguarding your investments during a bear market.
Factor-based Investing: Smarter Stock Exposure
Strategies like stock market factors are a great way to diversify your portfolio. Factor-based investing uses stock market index funds with specific characteristics that “tilt” the portfolio toward market segments that have historically shown an ability to provide long-term returns that have outperformed the overall market. These factors have excess returns with low correlation among each other, which can lead to a more diversified stock portfolio.
Factor-based investing has been refined by academics from institutions such as the University of Chicago, Stanford, Yale, and others. We invest in funds that meet “4 factors” we believe contribute to stock returns over the long run:
- High Quality: Companies with strong balance sheets and consistent profitability.
- Low Volatility: Stocks that tend to fluctuate less than the market average.
- Value: Stocks trading at relatively low valuation levels, such as so-called cheap stocks.
- Momentum: Stocks with positive trending returns over the last 6-36 months.
Factor-based portfolio construction that blends multiple factors can reduce the risk of any one strategy underperforming. For instance, value stocks alone have performed well over the last century, but not consistently. Meanwhile, combining all four factors has been shown to smooth out returns and reduce drawdowns, particularly in markets with low overall returns.
Alternative Investments: Expanding the Toolbox
With stocks becoming more expensive and bond returns not always high enough to meet many investors’ needs, alternative investments can provide additional tools for successful custom portfolio construction, offering income, diversification, and inflation protection. Alternative investments can include many different types of investments, such as:
- Hedge funds
- Real estate (through REITs or direct funds)
- Commodities (like gold, energy, or agricultural products)
- Infrastructure
- Private credit or private equity (via accessible pooled vehicles)
- Multi-strategy bond funds (combining various fixed-income approaches)
We believe alternative investments can be a great asset in helping to protect against large stock market declines and to pursue returns above those offered by the bond market, generally without taking on significantly higher levels of overall portfolio risk. However, caution is warranted in the alternative investment space. There are several issues to be aware of:
- Watch the fees. Many hedge funds and private equity funds charge high fees, which can significantly reduce your results unless your fund provides stellar returns.
- Pay attention to regulatory risk. Some alternatives, like hedge funds, are lightly regulated and not transparent (another reason to prefer mutual funds or ETFs).
- Ask about liquidity constraints. Direct alternatives can lock up capital for years.
We generally use more liquid alternative investments – not to “hit home runs,” but to reduce portfolio volatility and limit downside risk during bear markets.
Diversification with Zero Correlation
While diversification can include owning a lot of different investments, it’s slightly more complicated than that. After all, if you own many different assets, but they all behave the same, you aren’t truly diversified. Diversification is more about ensuring one investment will zig when the other zags.
For example, you can say you’re ‘diversified’ if you own several different tech stocks, but if that entire industry declines, your portfolio is going to take a big hit. Two investments with similar characteristics won’t necessarily add to your diversification. This is where the concept of correlation comes in:
- High (or positive) correlation means assets tend to move in the same direction.
- Low (or negative) correlation means one tends to rise when the other falls.
- Zero correlation means their movements are entirely independent.
In stock market downturns, like those we saw in 2008, 2020, or even more recently in 2022, many asset classes start to move together. For example, if U.S. stocks fall, assets that are supposed to be diversifying, like commodities, hedge funds, or even international stocks often fall, too. Moments like these highlights how true diversification only comes from assets with low or zero correlation to each other and that don’t show increased correlation when you need it most.
Putting it Together for Better Portfolio Construction
So, what does this look like in practice? Let’s say you aim for 7% annualized returns over the long term but want to avoid many gut-wrenching losses associated with the traditional portfolio approach. You might construct a custom portfolio like this:
| Component | Allocation | Role in Portfolio |
| Factor-based stocks | 50–70% | Enhanced risk-adjusted return |
| High-quality bonds | 10–20% | Stability and income |
| Alternatives (low-correlation) | 20–30% | Volatility buffer, crisis protection |
| Liquid reserves (cash, T-bills) | 0–5% | Liquidity for withdrawals or rebalancing |
This is just a framework, not advice. But it shows how you can move beyond the basic 60/40 model without overcomplicating things or taking unnecessary risks.
No one knows what markets will do next, but that’s the point of deliberate portfolio construction. It can help weather the storm when markets are choppy but should also reap the rewards when stocks rise to new highs. Smart portfolio construction can help you stay in the market, grow steadily, and avoid major mistakes when volatility spikes by:
- Seeking uncorrelated return sources
- Using factor-based strategies to improve stock exposure
- Allocating to well-chosen alternatives
You’ll likely end up with a more adaptive, resilient portfolio built for reality, rather than headlines. Though you won’t outperform every year, this strategy helps you position yourself to stay invested and achieve your long-term goals without too many sleepless nights. And that’s what our investment advisors consider a real win.
**Disclaimer**
As portrayed in this post, Armbruster Capital Management’s views are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Investing involves risks, and the value of your investment will fluctuate over time, and you may gain or lose money. Past performance does not guarantee future results.