The stock markets get the news, period. A glance at the evening news on NBC, CBS, ABC, etc. will give you a reasonable idea of how the stock markets performed during the day. Consistently downplayed, if not entirely ignored, are the results of the bond market in a given day. Have you ever seen performance numbers for the Barclays Aggregate Bond Index? Probably not. Nevertheless, bonds are a vital part of an investors portfolio. The single most important decision that an investor needs to make is their asset allocation.
What is asset allocation? It’s the mixture and distribution of different asset classes - typically stocks, bonds, and cash – in a portfolio. This decision alone represents about 90% of the portfolios total return.¹
Since 1926, only twice have U.S. government bonds posted a negative return in the same year large company stocks did. 2008 held true with the Barclays Aggregate Bond Index, a broad domestic bond market benchmark, up 6% while the S&P 500 was down -37% when factoring dividends. A portfolio invested 50/50 would yield an approximately -15.5%, a vast improvement over the recent carnage. In short, bonds provide some protection for bear markets while reducing the overall volatility, the key measure of risk, in a portfolio.
We’ve all heard the question: what stock should I invest in? In 2008 and in most down years, it generally didn’t matter. If you invested in domestic stocks, they were down -37% as a group. International stocks fared even worse around -45%. Emerging markets were worse yet at -54%. Whereever you invested in the stock market, with rare exception, you underperformed your expectations.
What should your asset allocation be? The decision is entirely dependent upon your individual circumstances. Don’t ever believe in or adhere to a one size fits all approach. Factors impacting this include your income, spending habits, additional source of money, risk tolerance, and age. However, a good starting point when looking at your retirement portfolio is to subract your age from 100 to determine your stock allocation. For example, if you’re 55 you should consider a 45% stock, 55% bond portfolio. If you don’t know how to invest in bonds, consider the iShares Barclays Aggregate Bond Fund, ticker AGG. It seeks to track the performance of the benchmark mentioned above.
Understanding the importance of asset allocation will make you a more savy investor and help you achieve your financial goals.
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You can’t mention return of any kind without also talking about risk. Stocks are riskier, so is the potential reward. This is why in aggregate they offer the best returns over time. Bonds are less risky and so in aggregate their returns are less.
Asset allocation is merely the result of properly identifying one’s risk profile. This is a great post, but risk needs a paragraph.
Philip, you’re absolutely correct. A post describing the definitions is almost warranted.
Thank you for pointing out the importance of asset allocation. Most people do not realize asset allocation is the main determinant of investment returns.
From an historical point of view Bonds have more risk and less potential reward than anytime in the last 50 years. After 30 years of rising bond prices and falling yields investors should reconsider having any bonds except TIPS in their portfolio.
Thank you.
Ken Faulkenberry
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