The takeaway: Asset allocation is the percentage of stocks and bonds in your portfolio. These percentages can supercharge your nest-egg or cause it to plod along. What should the percentages of stocks and bonds in your portfolio be? This post gives you standard rules of thumb to consider.
Who doesn’t want that?
In Part 1 we showed some amazing data about stocks vs. bonds. Specifically, we showed what would happen if grandma made a one-time deposit of $100 in the stock market and $100 in U.S. Treasury bonds back in 1927. We saw that today she’d have $328,645 in stocks and $7,110 in bonds. Over time, stocks provide notably higher investment returns than bonds.
We also showed how a portfolio that mixed stocks with bonds would have softened the losses that occurred in the Great Recession of 2008.
If in 1927, grandma had put $100 in the stock market and $100 in U.S. Treasury bonds, today she’d have $328,645 in stocks and $7,110 in bonds.“
In Part 3, we’ll discuss how asset allocation leads us to the holy grail of investing: buying low and selling high. However, to reach that holy grail we have to first know how to optimally allocate our portfolio.
Here’s today’s question: Exactly what percentage of stocks and bonds do you need in your portfolio to help maximize your gains and minimize your losses? (Recall that our discussion focuses on stock and bond mutual funds—preferably index funds. Index funds are a type of mutual fund and discussed here.)
To keep it simple, we’re talking stock and bond mutual funds.“
What are the most common rules of thumb for determining the percentage of stocks and bonds that should be in your portfolio?
There are three common rules of thumb. They all vary slightly. They state that the percentage of stocks in your portfolio should be either:
100 minus your age or;
- 110 minus your age or;
- 120 minus your age.
So if you’re 55, these rules of thumb would suggest that stocks comprise either 45%, 55%, or 65% of your portfolio–depending on which rule of thumb you choose. The percentage of bonds in your portfolio would be what’s left over.
Not comfortable with these rules of thumb? No problem.
In her book, How to Make Your Money Last, AARP’s Jane Bryant Quinn recommends between 40% and 65% of your portfolio be in stocks. But she notes you could stretch it as low as 35% and as high as 75%.
Still not comfortable?
Investopedia has examples of portfolios ranging from aggressive to conservative. See if any of these make you feel more comfortable.
The idea is to pick an allocation and stick with it.
What is the very best rule of thumb for determining the percentages of stocks and bonds that should be in your portfolio?
The very best rule of thumb is the Boomer Money and More rule of thumb. BMAM for short. It states that the best portfolio allocation of stocks and bonds is the one that lets you sleep at night.
The best allocation is the one that lets you sleep at night. If it keeps you awake, it’s too high! You’ll lose money.“
If you lay awake at night worrying about what the stock market is doing, then your allocation of stocks is too high.
If every day you check your portfolio and then turn on CNBC to see what the stock market is doing, your allocation of stocks is too high.
If this is you, hear me well gentle Boomer. You.Will.Lose.Money.
Because when the stock market goes down, you’ll panic and sell. Bulletin: when you sell, you’ll never get back to where you would have been had you not sold. Never. There’s simply not enough time or compound interest to help you catch back up. You’ve locked in your losses.
Here’s the fix.
Set an allocation that you can live with regardless of market conditions. When the market goes down, like it did in 2008, you’ll have already set a percentage that lets you ride out the storm. Take baby steps. But take the steps. Stocks, (i.e., stock index funds), are a valuable tool for helping ensure you won’t outlive your money.
Once you set this percentage don’t touch it for one year. (More on the “no touching” rule later in Part 3. There we discuss asset allocation as a tool to buy low and sell high.)
The Financial Analyst’s Journal, 50 state pension fund managers who invest billions each year, and Vanguard–one of the world’s largest asset management companies–all report research showing asset allocation is key to your investment returns.
Again with feeling: They say that the relative percentage of stocks and bonds in your portfolio is key to investment returns.
Financial Analyst’s Journal. In 1986 and again in 1991, research by Brinson, Hood, and Beebower, in the Financial Analyst’s Journal, reported that over 90% of investment returns could be attributed to how investors allocated their portfolio assets.
In layman’s terms, they were essentially saying that it almost doesn’t matter which stocks and bonds you pick! What matters is the percentage of stocks and percentage of bonds that comprise your portfolio.
Pension fund managers. As part of my public service job, I interviewed investment managers and evaluated each state’s pension fund. Virtually every state’s pension fund manager reported that asset allocation was the basis for their investment returns. These people invest billions each year.
Vanguard. In 2012, Vanguard’s own research on client portfolios showed that that 88% of investor returns were traced back to asset allocation.
Ignore the naysayers! Nearly all the experts say asset allocation is key to your investing success.“
Beware the asset allocation naysayers!
That’s not to say there aren’t some naysayers out there. Even big tobacco denied the harmful effects of cigarettes long after the dangers were well-known.
that works, they’ll say. It’s their own sheer brilliance at being able to pick the perfect stocks. They’ll say they know when to hold and when to fold (sell).
Recall my harrowing tale of picking one of these perfect funds managed by one of these “brilliant” investment managers. The research shows that, over the long-term, you’re better off setting your allocation and then placing your money in an index fund—since most fund managers can’t beat the market.
Next up: Buy Low, Sell High.
Boomer, asset allocation is the gold standard for your investments. It’s the work-horse that helps your money last as long as you do. In the next post, we’ll discuss how asset allocation sets the framework to enable you to buy low and sell high.
In the meantime, set an asset allocation that lets you sleep at night. Understand that you now know more about how to manage your portfolio than most investors.
Until next time, sleep well savvy Boomer. You’ve earned it.