This is a century old debate (if not longer) but it never gets old. Why? You can easily debate from either side. Don’t underestimate the impact of this decision though. For most investors, there are two main (and often only) asset classes; stocks and bonds. Sure you can add alternative classes like commodities, REIT’s, private placements, etc. You can also break down both of those into subclasses such as domestic stocks, emerging stocks, etc. Bonds can domestic or foreign, they can be short term, long term, inflation protected, corporate, government, etc. You get the picture right?
It Is Perhaps The Most Important Decision For Your Portfolio
It’s easy to get insanely complicated but hear me out. Asset allocation is by far the biggest factor in determining the performance of a portfolio. No other decision regarding asset allocation is more important than your allocation between stocks and bonds. Why? In theory, here is the breakdown:
Equities – Higher returns, more volatility, perform best in good economic times
Bonds – Lower returns, less volatility, performs best in flat/down markets
I know, I know, some might that dividend stocks for example react in a closer to bonds, etc. But let’s stick to bonds vs equities.
Which Asset Class Is Better?
Of course, there is no right answer to that. It always makes me smile when I see charts about bonds overperforming stocks (or vice-versa) because it always depends on one critical factor; the time period. I could easily pick a period that would show you how bonds outperform stocks or the opposite as you can see here:
It simply depends on the dates that I am using. The fact is that we should all own some stocks and some bonds. The big question is how much of each.
It’s NOT A Life Threatening Decision
One thing I hate to see is so many investors being unable to make a decision. They fear getting it wrong and want to over-analyze the decision. I know it’s difficult to come up with a set allocation… What you have to remember though is that the allocations will likely change every year and perhaps even more often. The critical part is getting started and then seeing how your portfolio reacts to market movements. Then, you can adjust both proportions to better reflect what you are looking for.
Make Your Life Easier
The universal rule is quite simple. If you own 100% of your portfolio in stocks and bonds you would invest so that:
Bond proportion = your age %
Stock proportion = 100% – bond proportion
So a 30 year old would own 30% of bonds and 70% of stocks. Of course, this is a general, well known rule meant to be easy to track and understand. I still think it’s a good starting point. From that point on, you can adjust in the following way:
-Higher tolerance/capacity to take risk => diminish bond % and increase stocks %
-Lower tolerance/capacity to take risk => increase bond % and diminish stocks %
What determines your willingness and capacity to take risk? Basically, an investor that can take risk and is willing to take more risk than the average investor would:
-sleep well at night no matter how the markets reacted
-be earning more than average or own more than the average
-not need aggressive returns to reach the target retirement
So basically, depending on your profile, you would adjust slightly your proportions. I personally consider myself more willing/capable of taking risks so the %bonds in my portfolio is less than my age. Not by tons, but it is.
I would love to hear what you think about this question and what you personally have been doing?