How Should You Allocate Your Retirement Assets? Stocks or Bonds?

Retirement asset allocation is one of the most misunderstood topics in retirement investing. Confused retirees may even revert to subtracting their age from 100 (or 120) to figure out their allocation of retirement assets – a common broker technique. If you’re 70, then 100-70=30 and means you should have 30% of your portfolio in stocks and 70% in bonds. Nifty, right? Well, no. That’s only taking one factor—your age—into the equation. What if you’re 70, but active and both your parents lived into their 90s? Of if you’re 70, but your spouse is 50? See how it starts to fall apart? There’s a lot more that goes into asset allocation in retirement.

This decision—which assets to have in your portfolio—drives return more than any other factor. In our opinion, 70% of your portfolio returns are dictated by this decision—certainly not one to be taken lightly.

The truth is there is no one “right” answer; it’s different for every investor. Furthermore, it is important to reassess as life changes arise and investment objectives shift. A general way to understand stocks versus bonds is if you have a long time horizon and need a higher return, you should weight more heavily to stocks. If you have a short time horizon or low return expectations then you may weight more heavily to bonds. If your situation is mixed, your asset allocation likely will be as well.

Stocks generally offer higher returns in exchange for increased short-term volatility. However, over time volatility (represented below as standard deviation on the charts below) tends to smooth out in stocks. This is why they’re so good for long-term investors. In fact, over thirty year periods stocks are actually less volatile than bonds.

Five-Year Rolling Periods

a chart of varying returns on retirement asset allocations.

20-Year Rolling Periods

30-Year Rolling Periods

Takeaway: This is the most important investment decision retirees make. You’ll have to take into account a variety of factors including your age, cash flow needs, time horizon, dependents, return expectations and more. Also, you’ll likely have to reexamine asset allocations as investment objectives change throughout the course of your retirement.

*Standard deviation represents the degree of fluctuation in historical returns. This risk measure is applied to five-year, 20-year and 30-year annualized rolling returns in the chart.
Source: Global Financial Data, Inc.; as of 2/12/14. Average rate of return from 1926-12/31/13. S&P 500 Total Return Index and US 10-year Government Bond Index.