Don't Stop With Stocks
Here at the Forecasts, we like stocks. But we stop short of advising readers to purchase them exclusively. Anyone who watched a stock portfolio erode during the broad market decline in 2008 and early 2009 should realize the importance of diversification.
Over long periods, stocks tend to outperform bonds. From 1926 through 2009, large-company stocks delivered annual returns of 9.8%, versus 5.4% for long-term government bonds. But from 1926 through 2009, long-term government bonds never delivered a five-year annualized return worse than a decline of 2.1%. Stocks, on the other hand, delivered a negative annualized return of 12.5%, or a loss in value of nearly 50%, from 1928 through 1932.
In general, adding bonds to a stock portfolio reduces both expected returns and risk.
Regardless of age, financial goals, and risk tolerance, most investors should own a mix of stocks and bonds. How much should you allocate to each asset class? There is no cookie-cutter answer. However, you can start with these four tips:
Let age be your guide. One rule of thumb holds that investors should maintain stock weightings equal to 110 minus their age. In other words, a 40-year-old should keep 70% of assets in stocks.
Customize your plan. Age is only one factor in the asset-allocation equation. Investors who require a lot of liquidity, have short time horizons, or are in poor health should raise their fixed-income exposure. All else being equal, investors with great wealth, good health, or high current incomes can afford to take more risk. For assistance customizing your retirement plan, visit our Asset Optimizer at www.DowTheory.com/go/Plan.
Begin at the end. Once you have an asset-allocation target, consider whether it will meet your needs. If your preferred asset mix is likely to generate 6% returns but you need 12% returns to fund your preferred lifestyle, then either your asset allocation or your return goals must change. Need help with this step of the plan? Try our Retirement Optimizer at www.DowTheory.com/go/Plan.
Don’t forget the cash. When you have determined how much of your assets to put in stocks, adjust it to reflect the recommended bond-fund position we present on page 3 and page 7. Holding a portion of your funds allocated to equities in Vanguard Short-Term Investment-Grade ($10.74; VFSTX), a short-term bond fund, provides flexibility for adding new stocks, as well as defensive ballast during rough markets.