Your investment portfolio’s asset allocation—its mix of stocks, bonds, cash and other securities—is a crucial determinant of long-term investing success. In fact, research from Fisher Investments shows that how you allocate your portfolio determines about 70% of your returns over time.
In our experience, many widely held beliefs, or “rules of thumb,” regarding asset allocation can lead investors astray. For example, the idea that stocks are generally “riskier” than bonds misses some important context. While a bond-heavy retirement portfolio may exhibit less short-term volatility, it could also mean a greater risk you run out of money if your goals require higher levels of growth.
Ultimately, we believe your asset allocation should target risk and return characteristics that match your financial goals and objectives.
What Is the Ideal Asset Allocation for My Investment Portfolio?
Many investors nearing retirement want to know how their portfolio should be invested. While some investment managers use age as their main determinant in recommending asset allocations, that approach ignores many other personal circumstances that should influence asset allocation.
Investment planning can vary from person to person. For example, not every retired 67-year-old has the same retirement savings, life expectancy or supplemental pension income. Some may want to spend all their money in retirement. Others may be looking further into the future, wanting to leave a financial legacy to heirs or charities.
The bottom line?
We believe your asset allocation should be aligned with your financial objectives. To reach your goals, you may need longer-term growth, which requires higher exposure to stocks. Or you may have a shorter investment time horizon, and a higher allocation of bonds may make sense.
Are Bonds "Safer" Than Stocks?
Some investors nearing retirement assume they should allocate a larger segment of their portfolio to bonds. They adopt this belief for several reasons, including:
- Bonds can provide a steady stream of income, something retirees often need to offset their living costs.
- Bonds can be less volatile, which might help hedge against market risk.
While these points contain some truth, we caution against making an asset allocation decision based on a “one-size-fits-all” approach.
Here are some additional points to consider:
Income Options: More Than Just Bonds
Bonds aren’t the only option for investors looking for retirement income.
You don’t have to rely strictly upon bonds to provide income after you have retired. In fact, doing so may be selling short your portfolio’s full potential. Why depend solely on income when your portfolio is capable of producing cash flow from selling stocks?
Keep in mind there is a distinction between income and cash flow. Income is money you receive. Cash flow is money you withdraw. The former is taxed as income; the latter is considered a capital gain (or loss). Both sources of funds are equally effective ways to pay for retirement. Your portfolio’s total return and after-tax cash flow—not whether it came from cash or income—should be your main concern.
How “Homegrown” Dividends Generate Cash Flow in Retirement
We think “homegrown” dividends are an often overlooked but ready solution for generating cash flow in retirement. When you selectively sell stocks for cash flow in a manner that strategically considers your longer-term financial goals and objectives, you create a “homegrown” dividend. For some investors, generating homegrown dividends could offer greater investment flexibility, potentially lower taxes, more portfolio personalization and more consistent cash flow.
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Low Returns
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Low Volatility
Low returns may shorten the length of time your investment portfolio can provide for you during your investment time horizon.
These days, retirement can last 30 years or more. Not having enough money to cover your retirement can be devastating.
In recent decades, the average investor’s time horizon has increased, which requires more money (and likely more growth) to meet long-term objectives.
You could run out of money for several reasons:
- Rising living costs
- Inflation
- Higher medical costs
- Supporting other family members during your retirement
Low volatility doesn’t necessarily mean low risk.
Many investors assume investing in stocks is riskier than investing in bonds because stocks are presumably more volatile than bonds. But bonds present their own set of risks (see “Bond Risks” below), and short-term volatility doesn’t necessarily lead to longer-term volatility.
Over longer periods, in fact, stocks are actually less volatile than bonds. As the accompanying charts illustrate, stocks’ standard deviation—a measure of the degree to which stock returns deviate from the average—tends to “smooth out” over time.
Moreover, equities have outperformed bonds 100% and 97% of the time, respectively, during 30-year and 20-year rolling periods since 1926.1
For this reason, you might want to consider allocating a larger portion of your portfolio to stocks to achieve the growth necessary to cover retirement.
Additional Risks to Consider
Volatility risk shouldn’t be the only consideration when choosing stocks or bonds. There are other often overlooked risks that bonds and stocks can present.
Bond Risks
Credit Risk
The bond issuer may be unable to pay interest or repay principal.
Liquidity Risk
Some bonds cannot easily be bought or sold. This can tie up funds or force investors to accept less favorable pricing.
Reinvestment Risk
Interest payments and cash from maturing bonds may have to be reinvested at lower rates if interest rates are declining. This means you may end up spending more for smaller returns.
Interest Rate Risks
A rise or fall in interest rates may work against your bond allocations. Bond prices and interest rates have an inverse relationship, which means bond prices fall when interest rates or inflation rise.
Stock Risks
Volatility Risk
Higher short-term price volatility is possible with stocks.
Principal Risk
Investors can potentially lose principal if companies do poorly or go bankrupt.
Dividend Risk
Companies can possibly reduce or revoke dividends.
Should Bonds Be Part of My Investment Portfolio?
We believe that bonds, when used correctly, can play a crucial role in helping reduce short-term volatility in an investor’s portfolio.
While not everyone needs to reduce short-term volatility, bonds can help dampen the effect of stock market swings particularly for people with high cash-flow needs or a short time horizon.
What makes sense for you depends on your personal situation and goals.
We Are Available to Help Address Your Asset Allocation Questions
There is no one correct asset allocation strategy. Every investor has unique financial circumstances, goals and risk tolerance—but you don’t have to go it alone.
At Fisher Investments, we are committed to understanding your financial needs. We can help you strategically allocate your assets between stocks, bonds and cash to diversify your investment portfolio and address your longer-term financial goals.
The contents of this document should not be construed as tax advice. Please contact your tax professional. Investments in securities involve the risk of loss. Past performance is no guarantee of future returns.
1Source: Global Financial Data, as of 12/31/2023. 5- and 30-year rolling returns from 12/31/1925 to 12/31/2023. Equity returns based on the S&P 500 Total Return Index. Fixed Income returns based on Global Financial Data’s USA 10-Year Government Bond Index.
Definitive Guide to Retirement Income
Do you know how much your retirement will cost? Do you know how to generate the retirement income you’ll need? This guide will help you find answers to these and other important questions.
FAQ
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An investment portfolio’s asset allocation is its mix of stocks, bonds, cash and other securities—and is a crucial determinant of your portfolio’s returns over time.
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Strategic asset allocation is building a mix of stocks, bonds, cash and/or other securities to diversify your portfolio in a way that aligns with your long-term financial goals.
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Your asset allocation should reflect your unique financial circumstances, needs and goals. For example, if your financial goals require higher levels of long-term growth, you may need a higher level of equity exposure. Or, if you have a shorter time horizon or higher short-term income needs, more bonds and/or cash may be appropriate.
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Tactical asset allocation is a shift in active portfolio management, where short-term adjustments are made to portfolio allocations to capitalize on temporary trends or mitigate potential risks. For example, stocks might be de-emphasized and bonds and/or cash may be preferred when trying to mitigate the impact of falling stock prices if a bear market has been identified.
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Your asset allocation is the largest determinant of your portfolio’s returns over time—more than sub-asset allocation (i.e., large vs. small, growth vs. value, etc.) and individual security selection. Fisher Investments’ research shows that asset allocation determines about 70% of your portfolio's long-term returns.
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Diversification refers to the blending of different types of investments to reduce volatility and risk, while asset allocation is specific to the mix of stocks, bonds, cash and other securities in your portfolio.
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