Determining the Mix of Stocks and Bonds in Your Portfolio

Early this month, there’s an article on Morningstar.com discussing the allocation of stocks and bonds in an investment portfolio. Determining the right mix of stocks and bonds depends on many factors, such as age, risk tolerance, and return expectation. For aggressive investors with longer time horizon, they can afford to put a large port of their investments in equities, if not 100%, to seek higher return and growth at the early stage of investing. As time goes by, the focus of investments changes from growing money to preserving capital and, accordingly, investment strategy becomes more conservative.

But what is the right mix of stocks and bonds? If you don’t know how to determine your own stocks/bonds allocation, you may get some clue from the target date funds (or lifecycle funds), which adjust the allocations for investors as the target date approaches. The following is a table of equity allocations in some target date funds from 2005 to 2045 in the Morningstar article.

Target date Avg. Equity (%) High (%) Low (%)
2005 48 59 43
2015 67 84 46
2025 79 97 61
2035 86 99 60
2045 88 99 60

However, as it shows in the table, even for funds with the same target date, the difference between the highest and lowest allocations is quite substantial (a 39% gap for 2035 and 2045 funds), reflecting each fund manager’s view on the balance between risk and reward. In fact, when I looked at some target date funds from Vanguard, Fidelity, and T. R. Price early this year, I got the conclusion that not every lifecycle fund is created equally, though in that case, the difference is not as large in the Morningstar article.

Though Treasury bonds are regarded as safe heaven when the market is volatile (like the one we are experiencing now), holding too much cash/bonds on hands can do more harm than good for the long term as it will hamper investors’ efforts to reach to reach their financial goals. The long term return of bonds is much lower than that of equities. To me, it really doesn’t make too much sense to have some 30-40% in bonds when I have some 30 years before I use the money. Generally, as pointed out in the article:

investors in their 20s and 30s can glean that they should have upward of 80% of their assets in stocks and stock funds, and even those already in retirement should consider devoting a healthy portion of their portfolio to equities.

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4 Responses to “Determining the Mix of Stocks and Bonds in Your Portfolio”

  1. The Dividend Guy |  Nov 26, 2007 at 3:18 pm

    Important post as approximately 70% of an investors return is dictated by the asset allocation that is selected. Going aggressive does not necessarily mean higher returns – the important thing is to pick an allocation and stick to it long term.