Your Bond Percentage Should Feel Uncomfortable
If you’re following this blog, you’re going to see a lot of discussion around asset allocation and building a portfolio to reach your goals. I’m eager to dive in to investment planning and modern portfolio theory, but let’s just get our feet wet today.
One of the first big questions you’re likely to encounter as you construct an asset allocation plan is “What share of my investments should be in stocks and in bonds?” In William Bernstein’s The Intelligent Asset Allocator, the author demonstrates that nearly all historical differences in the long term risk and return of investment portfolios are determined by the stock-to-bond ratio. While specific equity classes within the portfolio matter a lot in the short term, they are less and less important as time goes by†. Your stock-to-bond ratio is foundational to your investment plan.
So how do you decide what percentage of your investments should be in bonds?
There’s an old rule that your bond percentage should be equal to your age. For example, when you’re 25 you should use 25% and when you’re 75 you should use 75%. This reflects the wisdom that for many people as they get older their time horizon shortens and they’re more interested in managing risk than maximizing returns. More recently, a similar but more aggressive stock percentage of 110 or 120 minus your age has become more popular. This makes some sense as life expectancy continues to grow, you need your investments to last longer in retirement.
The specific guideline you choose probably isn’t as important as the following considerations:
1. By far, the largest risk and greatest damage potential at every stock-bond ratio is YOU. Your emotions will cause you to change your plan at the worst times. You’ll feel irrationally exuberant at the top of the market, succumbing to aggression and leverage as you try to get in on the party or you’ll feel irrationally gloomy and sell off at the bottom of the market, succumbing to fear and anxiety when things look grim.
2. If you haven’t ever personally experienced the zeal and angst described above, I humbly suggest a more conservative (i.e. more bonds) allocation, at least until you’ve met exuberance and gloom without blinking.
3. And if you’ve been through some upturns and downturns and feel confident you will stay the course, perhaps the words of Vanguard Founder Jack Bogle will give you guidance and a better night’s sleep:
“I’m about 50 percent stocks and 50 percent bonds and I spend half my time worrying about why I have so much in stock and the other half worrying about why I have so little in stocks.”
I think I’m just about in the same place as Mr. Bogle, depending on the day of the week you’ll find me muttering about being under or over invested in bonds. So I think I’m at a good place, and I’ll stick to my plan. What’s your bond allocation? Please share your thoughts in the comments below!
†Given some conditions like a basic level of diversification.