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!).
The 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.