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As a subscriber to Kiplinger’s Personal Finance
magazine, every once in a while I run across a piece of information that I find really valuable. In this month’s edition, there was an article about hedging your bets and one of the topics was the impact if slightly reducing your equity exposure to reduce the volatility of your portfolio. Sure, you give up some future gains but the difference is not worth doing given the volatility and additional risk more equity exposure gives you.
In the image below, you can see the impact a slight reduction in stock exposure has provided. Pay particular attention to the “Worst” column as that is the thing that can get investors into a lot of trouble. Really bad volatility, and ultimately really poor returns from time to time, make investors act with their emotions and make stupid mistakes. I have done it, have to really try hard not to do it, and will probably do it again. However, I have protected myself slightly by reducing stock exposure (I still have work to do here!).
Click to EnlargeThe rule I like to use to determine the split between stocks an bonds is the simple one advocated by John Bogle – keep the fixed income component of your portfolio equal your age. If you are 35 years old you should have 35% in fixed income and 65% in equities. Easy, simple, and effective in my experience.
According to that chart a 30% stock / 70% bond never lost money over any 5 year span. I find that nearly impossible to believe especially with 2001 and today’s 2008 crashes.
I believe it, though I am sure it didn’t earn a lot either. But over a 5-year period, I suspect it is accurate.
It’s very annoying to deal with financial planners who ignore that you should have bonds in your portfolio – this happened to me at age 55 when I tried to roll over a bond, and told the planner I was retiring soon. He objected to the idea of the rollover and made no recommendations to alter my portfolio. Of course he didn’t make any $$$ on the bonds.
I like the picture chosen to accompany the June 24, 2009 post. It reflects some of the dire possibilities.
@Brad: Bear in mind that 2001, for example, was surrounded by the end of the tech boom and the start of the housing market boom; finding a five year period where a conservative portfolio would lose money, even including 2001, would be quite hard.
While I like the idea of increasing your bond portfolio over time, I think that a simple rule like ‘hold your age in bonds’ (or the similar, 120-your age = percent you should have in stocks) has some problems. When you’re young (in your twenties or so) it suggests you should have a substantial portion in bonds, even when you have decades to go before you will need your money. On the other end, it suggests you need almost no stock exposure in late retirement, even though people are living past 100 every day. (To say nothing of having funds for your children and others to inherit.)
Something a bit more complex, like ‘Add ten percent bond exposure to your portfolio every decade from age 30 to 60’ is much less quotable, but would be more accurate for what you should really do.
The trouble is that most people (especially those early in their investing careers) do not have the discipline to sit tight when that 100% equity portfolio gets thrashed around. That 20% in Fixed Income can act as a nice buffer to the volatility. That being said, I find your approach interesting.