Your portfolio’s asset allocation—its mix of stocks, bonds, cash and other securities—is a crucial determinant of long-term investing success. In fact, our research shows how you decide to allocate your portfolio accounts for about 70% of your returns over time.
In our experience, many widely held beliefs or “rules of thumb” surrounding how to determine your 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 provide less short-term volatility, it could also mean a higher 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 commensurate with your financial goals and objectives.
What Is the Ideal Asset Allocations for My Investment Portfolio?
Many investors nearing retirement want to know how their portfolio should be invested. Some investment managers use age as the main determinant of an asset allocation recommendation. However, this approach ignores many other personal circumstances that should influence one’s asset allocation. For instance, not every retired 60-year-old has the same amount of retirement savings, life expectancy or supplemental pension income. Retirement plans and legacy planning can also vary from person to person.You may be looking to leave a legacy to heirs or spend all of your money in retirement. These are all individual factors that could be over-looked in a traditional age-based asset allocation.
We believe your asset allocation should be aligned with your financial objectives. For example, some investors need longer-term growth to reach their goals—thus requiring higher exposure to stocks. Others may have a shorter investment time horizon, in which case a higher allocation of bonds may make sense.
Are Bond's Safer Than Stocks?
Some investors nearing retirement often assume they should allocate a larger segment of their portfolio to bonds 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 can make them a portfolio 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:
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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.
Not having enough money to cover your retirement—which could last 30 years or more—can be devastating. In recent decades, the average investor’s time horizon has increased—leading to an increase in the amount of money (and likely growth) needed to meet long-term objectives. You could run out of money for several reasons, including:
- 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 bonds, citing stocks’ higher volatility. But bonds present their own set of risks (see next section) and 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, stocks’ standard deviation—a measure of the degree to which stocks’ returns deviate from the average—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 You might want to consider a more stock-heavy portfolio allocation to achieve the growth necessary to cover your retirement.
There Are Other Risks to Consider Too
Volatility risk shouldn’t be the only consideration when it comes to 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, which 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, meaning they move opposite one another. So bond prices fall when interest rates or inflation rise.
Stock Risks
Volatility Risk
Possibility of higher short-term price volatility.
Principal Risk
Possibility of losing principal if companies do poorly or go bankrupt.
Dividend Risk
Possibility of companies reducing or revoking dividends.
Bonds Can Play An Important Role For Many Investors
With that being said, we believe bonds, when used correctly, can certainly play a crucial role in investors’ portfolio strategy. We believe the primary benefit bonds provide is helping to reduce a portfolio’s short-term volatility. Not everyone needs this feature, but if you have high cash-flow needs or a short time horizon, bonds can help dampen the effect of the stock markets’ swings. What makes sense for you depends on your personal situation and goals.
Beyond Bonds: Another Approach to Generating Retirement Income
You don’t have to rely strictly upon bonds to provide income after you have retired. 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? Remember there is a distinction 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). 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.
We think there is an often overlooked but ready solution for generating cash flow in retirement investors’ toolkits—homegrown dividends. A “homegrown” dividend is when you selectively sell your stocks for cash flow in a manner that strategically takes into account your longer-term financial goals and objectives. Homegrown dividends can allow you to maintain proper diversification in your portfolio—and if done properly, they can be tax efficient.
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 with strategic asset allocation between stocks, bonds and cash to diversify your investment portfolio and match 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.
1 Source: Global Financial Data, as of 2/22/2022.
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