With bond markets selling off, 60/40 investors are once again in a tight spot.
While there is no cure-all for treacherous market conditions, there are some tweaks you can make to smooth returns, such as targeting defensive stocks and considering alternative investments, including commodities.
All eyes on Wall Street have been focused on the bond market, where the 10-year Treasury note briefly climbed past 4.7%, close to its highest levels since early 2025, and 30-year yields are higher than they been in nearly two decades. That has put a drag on bond returns, since bond prices move in the opposite direction to prices.
For investors in 60/40 funds-which invest 60% in stocks and 40% in bonds-the situation is one of familiar frustration. These funds have returned 8% this year on average, according to Morningstar, far behind the 13% for the S&P 500. That's in large part because bonds' contribution has been negative in 2026, with the Lehman Aggregate Bond Index delivering a negative return of about 0.2%.
But what's more troubling for 60/40 investors is that big risks remain.
While stocks have bailed out 60/40s overall returns this year, the stock market is harnessed to an AI trade that looks increasingly volatile. The reasons behind the bond selloff are worrisome too: rising interest rates appear to be driven by concern about spiraling U.S. debt levels, not optimism about economic growth. That could make it harder for the Federal Reserve to pull down rates in the event of a stock selloff-raising the prospect both stocks and bonds could sell off at the same time.
"The 60/40 portfolio is broken because equity returns are driven by AI concentration rather than the business cycle, while bond returns are now driven by fiscal constraints rather than cycle dynamics," wrote Torsten Sløk, Apollo's chief economist in a note this month. "The real risk emerges if the AI trade reverses or markets become more worried about government deficits. In either scenario, both stocks and bonds would face pressure simultaneously, leaving investors with no hedge."
For 60/40 investors the current climate recalls the nightmare of 2022, when runaway inflation prompted the Federal Reserve to raise interest rates, sending stock and bond prices south at the same time. The average 60/40 fund tumbled 14%, and the category put up its worst return in decades.
Unfortunately, there is no perfect answer for investors who want to avoid a repeat. One obvious answer would be to shift money out of bonds, which have delivered years of dismal returns, into areas of the stock that might hold up well even in an AI selloff. The problem is in recent years the AI trade has spread its tentacles into almost every corner of the stock market.
Energy (up 44%) and industrials (up 18%) are among the hottest sectors this year. But those have been riding high thanks in part to AI power demand in the surge in data center building. Emerging market stocks are up more than 20%, although chip companies in Taiwan and South Korea have driven much of those gains.
In other words, there aren't a lot of places to hide. Still, in a note last week Bank of America Global Securities took a stab at finding some.
"What stocks are working with no AI dependence?" asked strategist Jared Woodward. "Biotech, insurance, regional banks & revenue-weighted small-caps have returned near 10% or more since June," benefiting from a temporary rotation to defensives from AI names.
So far so good. Except that bond investors who are also trying to protect their portfolios against rising interest rates should also probably steer clear of regional banks and small caps stocks. Regional banks were among the hardest hit sectors when rates spiked in 2022, and small caps, which tend to have weaker balance sheets and larger debt loads, also didn't fare well.
A better bet may be healthcare stocks, a sector with relatively little AI exposure that also tends to be defensive. BofA recommends the State Street SPDR S&P Biotech ETF. Investors can also get broader exposure with State Street Health Care Select Sector SPDR ETF. While healthcare has lagged in recent years thanks in part to patent cliffs at major drugmakers, a spate of acquisitions and improving sentiment over insurers has driven a rebound, with the Select Sector fund up nearly 17% in the past three months.
Investors can also try diversifying beyond just stocks and bonds, with options like commodities and alternative funds promising to provide a third layer of diversification. One recent study by BlackRock found adding "liquid alternatives," including hedge fund strategies, like long-short equities and managed futures, improved the 60/40 strategy's risk-return profile.
"At a similar level of risk to a traditional 60/40 portfolio, including a 20% allocation to liquid alternatives increased returns from 6.7% to approximately 9.2%," wrote the study authors. "Conversely, at a similar level of return, volatility declined from 11.6% to approximately 9.3%."
Picking alternative funds can be tricky, especially since many use derivatives that can make parsing holdings hard. AQR Diversifying Strategies is a traditional mutual fund that bundles several liquid alternative strategies, and its 12% average annual return ranks it among the top 10% of funds in its category, according to Morningstar. There are relatively few ETFs that offer hedge fund like strategies, but one with a solid record is First Trust Multi-Strategy Alternative ETF, which has returned 9.9% annually over the past three years, putting it the top 26% of its category.
Owning commodities is another way to add diversification, without all of the complexity of hedge-fund-adjacent strategies. Studies have long contended commodities can smooth stock and bond returns. A recent paper from Morgan Stanley noted that was especially true during market shock prompted by the U.S. attack on Iran earlier this year. While a 60/40 portfolio would have posted a 3.6% loss during the month following the attack, one with a 5% commodity allocation would have gained 1%, the paper found.
Gold has long been a go-to for investors looking for a simple commodity solution. But the yellow metal is still relatively close to the all-time high it set in January, and investors who own just gold would have missed out on the recent run up in oil prices. A broader option is the Invesco DB Commodity Index Tracking ETF. The fund has about half its holdings in energy, with the rest split evenly between agricultural products and metals.
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