How Much Should You Invest in Stocks versus Bonds?

I've seen a wide range of rules for how much any investors should invest in stocks and how much in bonds. Each of the basic philosophies are consistent -- high on stocks if there's a long time until you need the money and increasing in bonds as you get closer to needing the money -- but somehow they all end up with a different percentage in each of the two options.

Well, here's another one to add to the mix. This one is from Kiplinger's and suggested their thoughts on the split between stocks and bonds:

How much should you put into bonds? If you're investing for retirement, keep 90% or more in stocks until you're within six years or so of retirement. Then gradually start selling your stocks until you're 40% in bonds by the time you retire.

If you're investing for your child's education, also start with 90% or more in stocks and begin scaling back when he or she gets within ten years or so of college. Then gradually sell your stock funds first and then your bond funds until you're entirely in cash by the time your child is midway through college.

This is probably the most aggressive formula I've seen (aggressive meaning that the percentage invested in stocks is fairly high and stays fairly high.) That said, if anything I'm MORE aggressive than this model. I'm almost 100% in stocks and if there's any weakness in my portfolio it's that I'm short on bonds. I need to look at my allocation seriously as I'm rebalancing this year. I'd be ok with the 90/10 split, but it will take some work to get there.

Comments

[Miserly Bastard]

Stocks get a lot of attention from the asset allocation crowd, especially international, small cap, and value stock indexes. The problem is that equity correlations have all gone up since the 1970s when the original academic research was written, and now US equities have something like a .8 r-squared with European equities (but lower correlation with Pacific equities). Small cap, of course, is all positively correlated with the broad market index, except with more volatility.

So one reason to own bonds is because of the lower rate of correlations between that asset class and stocks. This is still something short of a prescription, however, because the spread to treasury on corporate offerings is at an all-time low, so you are not getting compensated for much of a risk premium. Thus, if you "diversify" into bonds at this point in time, you're buying into the asset class at a peak.

My own view is that for the moment, cash is a fairly attractive asset class right now in lieu of bonds.