Asset Allocation for Retirement:
Balancing Stocks vs. Bonds

The assumption that stocks are generally riskier than bonds seems to be a widely accepted piece of investment wisdom. If this were true, a bond-heavy retirement portfolio consisting of bond mutual funds or fixed income exchange-traded funds (ETFs) would make for a safer investment than a portfolio with a heavier stock allocation. The problem is this piece of “common wisdom” isn’t sound. In our view, it’s misguided.

What Is the Ideal Asset Allocation?

Many investors who are entering or already in retirement want to know how much of their portfolio should be invested in stocks and bonds—and what the right mix of those assets should be in order to grow or receive income from their portfolio. Whether your goal is growth or income in retirement, your asset allocation should be in line with that objective because it can play a critical role in achieving your retirement goals.

Many investment managers rely on strategies where age is the main determinant of an asset allocation recommendation. However, this can be detrimental over the long term. For instance, not every retired 60-year-old has the same life expectancy or supplemental pension income. You may be looking to leave a legacy to heirs or spend all of your money in retirement. These are all individual factors that may be over-looked in a traditional age based asset allocation.

Why Bonds Aren’t Necessarily Safer Than Stocks

Investors often assume they should allocate a larger segment of their portfolio to bonds for several reasons, believing:

  • Bonds may provide a steady stream of income, something retirees often need to offset their living costs.
  • Bonds may be less volatile, which can make them a portfolio hedge against market risk.
  • Many financial advisors recommend that clients nearing retirement should allocate more to bonds than stocks to decrease risk.

Low returns may shorten the length of time your portfolio can provide for you during your investment time horizon.

Not having enough money to cover your retirement—a potentially lengthy time horizon that can last up to 30 years or more—can be devastating. You may run out of money for several reasons, such as rising living costs, inflation, higher medical costs and, in some cases, supporting other family members during your retirement. As one would imagine, with the advances in medical technology, the average investor’s time horizon has significantly increased, thus leading to an increase in the growth needed to meet long-term objectives.

Low volatility doesn’t necessarily mean low risk.

Many investors assume investing in stocks is riskier than bonds, citing stocks’ higher volatility. But short-term volatility doesn’t necessarily lead to volatility in the longer term.

You might be surprised to learn that over longer periods, equities are actually less volatile than bonds. As the following charts illustrate, a stock’s standard deviation—a measure of the degree to which  a stocks return deviates from its average return—tends to “smooth out” over time. Moreover, equities outperformed bonds 100% of the time during 30-year rolling periods and 97% of the time during 20-year rolling periods since 1926.1

5 and 30 year rolling periods for equities

As stock market gains have outperformed bonds over a 30-year period, you might want to consider a more stock-heavy portfolio allocation to achieve the growth necessary to cover your retirement.

Bonds’ inverse relationship.

A rise or fall in interest rates may work against your bond allocations. Bond prices and interest rates have an inverse relationship, meaning they move opposite one another:

  • When interest rates fall, bond prices rise.
  • When interest rates rise, bond prices fall.

If you reinvest in bonds when yields are down, you may end up spending more for smaller returns. And if you switch to higher-yielding bonds, you may end up investing in bonds that are inherently riskier due either to their lower credit quality or longer period to maturity.

Imagine the opposite scenario, one in which interest rates dramatically rise. Suppose you need to convert your bonds to cash due to unanticipated expenses, such as a large medical bill, a home purchase or any other necessary or discretionary purchase. Cashing out your bonds while interest rates are high means you may end up losing money, because you would likely receive less for the bonds than what you had initially paid.

In our view, using bonds to drive returns is a common mistake. We believe the primary benefit bonds bring is helping to reduce a portfolio’s volatility. Not everyone needs this feature, but if you have high cash-flow needs, it can make sense to help dampen the effect of the stock markets’ swings.

Other Strategies to Generate Income During Retirement

The good news is you don’t have to rely only on bonds to provide income after you have retired. You can use other approaches:

  • Income and cash flow. Relying solely on bond income for your retirement 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? Remember there is a keen distinction to be made between income and cash flow: Income is money you receive, while cash flow is money you withdraw. The former is taxed as income, while the latter is considered a capital gain (or loss).
  • Focus on total return. Both sources of funds are equally effective ways to pay for your retirement. A big concern should be your portfolio’s total return and after-tax cash flow—not whether it came from cash versus income.
  • Homegrown dividends. A “homegrown” dividend is when you sell your stocks for cash flow in a manner that strategically takes into account your longer-term financial goals and objectives. Homegrown dividends allow you to maintain a well-diversified portfolio—and if done properly, they can be tax efficient. In certain situations, long-term capital gains can be taxed at a lower rate than bond income, which may be taxed as ordinary income depending on the type of bond investment. .

Where to Get Help

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 provide you with an Investment Counselor and a dedicated team who are committed to understanding your financial needs. We can help you with strategic asset allocation between stocks, bonds and cash to diversify your portfolio investments and match your longer-term financial goals.

Contact us to learn more!

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.


1 Source: Global Financial Data, as of 4/11/2017.