By Dr. James M. Dahle, WCI Founder
I fully understand the desire to use a 100% stock portfolio. Once somebody looks at past behavior of the stock market and understands the general rule between risk and return, it seems obvious to question why they might want to put 10%, 25%, 40%, or more of their portfolio into those pesky low-returning bonds. I mean, look at the data:
The intermediate investor looks at that data and thinks, “If I can get 10.1% returns instead of 9.5% returns, over 30 years that means I end up with 12% more money. Or I can retire over a year earlier with the same amount of money. All I have to do is tolerate losing a little more of my money in a bear market. I'm sure I can do that since stocks have ALWAYS come back….eventually.” People also have an understandably hard time getting excited about investing in bonds given current yields of 0.1-3%, especially when they understand that the best predictor of future nominal bond returns is current yield.
Should You Rebalance Your All Stock Portfolio?
However, today we're going to poke some holes into the argument for 100% stocks. Now, if at the end of this article you still want a 100% stock portfolio, knock yourself out.
But I think any 100% stock investor owes herself two things:
- Fully understand the arguments against a 100% stock portfolio
- Pass through her first bear market and STILL feel comfortable with a 100% stock portfolio
Obviously, obeying those two requirements rules out the opportunity for any investing virgins (anyone who hasn't invested in a bear market) to have a 100% stock portfolio. That's probably a good thing. A 100% stock proponent might then argue, “But that means that anyone who has started investing in the last decade can't have a 100% stock portfolio when their risk tolerance should be highest at the beginning of their career.” To which I would reply, “The fact that we haven't had a real bear market in a decade is not an argument for increasing your stock allocation.” Besides, there were (admittedly short) bear markets in the summer of 2011, December 2018, and March 2020, so that excuse really doesn't fly.
All right, let's get into it.
#1 Why Not 130% Stocks?
I never see threads arguing for 95% stock portfolios. Nor 105% portfolios. It's always 100%. I'm not sure what the fascination with that round number is other than it is round. If 100% stocks is good, 110% stocks must be better, right? How do you get 110% stocks? Well, debt is basically a negative bond. So if you borrow 10% of the size of your portfolio and invest the entire portfolio plus that 10% in stocks, you have a 110% stock portfolio. In truth, it doesn't matter what the source of that debt is. If you have student loans and a mortgage and a relatively small portfolio, in reality, you may already have a portfolio that is already > 100% stocks. If the possibility of a margin call scares you (and it should) then don't borrow against the portfolio, borrow against your house to get there. Actually, don't. At least not until you've read this fascinating thread started in 2007 and progressing through the Global Financial Crisis.
#2 Why Not 100% Small-Value Stocks?
The primary reason people cite for 100% stock portfolios is because in the long-run, at least in the United States, a 100% stock portfolio has had higher returns than a portfolio that contained any percentage of bonds—although at the extremes the “cost” of a few bonds or a few stocks isn't very high, as you can see in this chart:
We can carry that higher return argument out further. Long-term data suggests that small-value stocks outperform the overall market. So if you're just going for the highest possible return, you should use a portfolio that is 100% small-value stocks.
A factor investing fan would argue you're even MORE diversified doing that, since you are now taking not only market risk, but also size and value risk. Does a 100% small-value portfolio make you feel uncomfortable? You don't want to put all your money into what accounts for just 2% of the stock market?
The same reason you feel uncomfortable with a 100% small-value portfolio should make you uncomfortable with a 100% stock portfolio. It's a very big bet on the future resembling the past.
#3 Bonds Might Outperform Stocks
There have been long time periods in the past when bonds outperformed stocks, even in the US, and even longer time periods in other national markets. It might not be “normal” but it does happen. The problem is we all get seduced by stocks when we look at tables like this one:
(By the way, that's a really fun chart to pull out when the gold bugs start doing their thing too.) But if you carefully examine shorter time periods, you'll see that there are many periods of time where bonds outperform stocks for quite a while. Take a look at this chart of rolling 10-year periods:
As you can see, stocks outperform bonds most of the time over 10 years, but nowhere near all the time. It becomes especially noteworthy if you also include all those 10-year periods when stocks barely outperformed bonds while taking far less risk. Even at 15 years, a bet on stocks hasn't always worked out well. In this chart, S&P 500 stocks are compared to 5-year treasuries.
15 years can be a long time. Consider where you were financially 15 years ago. 15 years ago I had a four-figure net worth as a brand new intern. Now, imagine you've been investing ever since then in a 100% stock portfolio and you're STILL underperforming a 100% bond portfolio. It happens. It has happened even more frequently outside of the United States. Check out the real (after-inflation) equity returns from various countries:
As you can see, US bonds outperformed some of those countries over more than a century! That might be twice as long as your investing career. Maybe the future looks more like Japan or heaven forbid, Austria, rather than the US or South Africa. This idea that stocks always outperform bonds over 20+ year periods really only applies to the US and the comparative advantages the US has enjoyed in the past were significantly higher. (To be fair, some of the bond returns of these countries were even worse than their stock returns!)
More recently, I saw a post that looked into stock versus bond returns in the US, but not over the typical time period that we look at. If you start in 1793, there is a 150-year period where bonds outperformed stocks!
I look at all this data and to me, as a long-term investor, the message is clear. Bet on stocks, but don't bet the farm. A 100% stock portfolio is betting the farm. The future may not resemble the past at all or we may have one of those periods like the 1930s, 1970s, or 2000s.
When I constructed my portfolio, I made a few assumptions:
- Stocks would outperform bonds.
- Small-value stocks would outperform the overall stock market.
- US stocks and international stocks would have similar returns with a correlation of less than 1.
- Stocks and real estate would have similar returns with a correlation of less than 1.
As you might expect, my portfolio reflects those assumptions. But I also wanted a portfolio that was highly likely to reach my financial goals even if one or more of my assumptions turned out to be wrong. I tried to avoid making any big bets that would sink me if they were wrong. As such, I hold lots of stocks, but didn't go “all-in” with a 100% stock portfolio. I have a significant small-value tilt, but I also own the entire market. I own both US and international stocks. I own both stocks and real estate. The goal of investing isn't to win, it's to not lose. Consider both the likelihood that your assumptions are wrong AND the consequences when designing your portfolio.
#4 Easier to Stay the Course
I think it is a big mistake for a new investor who has read a book or two on investing to assume they will be able to tolerate a stock-heavy portfolio in a bear market. When setting up a portfolio in “normal times” lots of stocks make logical sense. But staying the course in a bear market is not a logical experience. It is a profoundly emotional one. Watching money that used to be yours disappear is psychologically painful. That money represents the kitchen upgrade you didn't do, the Tesla you didn't buy, the vacation you didn't take, and the piano lessons you didn't give to your child. Investing more as the market drops day by day and the talking heads on TV are screaming “This is the end” feels like shoving hundred-dollar bills down a rat hole. Ignore the critical behavioral aspect of investing at your peril.
Having SOMETHING invested in bonds at those times not only reduces the volatility of your portfolio but also gives you the psychological reassurance that “At least I didn't put it all in the market.” In fact, your bonds (at least the high-quality ones) are likely RISING in value at that time, providing you reassurance that something you own is actually increasing in value and moderating the volatility of the entire portfolio. You get to say to yourself, “Now I've got some dry powder I can put to work so I can buy stocks while there is blood in the streets,” even if deep down you know that is just a psychological crux and you really don't want to hold “dry powder”.
All of that helps you to stay the course, which is the most critical aspect of investing. You are far better off holding a 60/40 portfolio for decades than a 100% stock portfolio that you sell low just once during your investing career. Avoiding the investment catastrophe of selling low is the most important aspect of portfolio construction. Far better to underestimate your risk tolerance than overestimate it. It's kind of like The Price is Right, where you try to get as close as you can to your risk tolerance without going over.
You really don't want to pull a Happy Gilmore and find out “The price is wrong, Bob!”
#5 Experienced Investors Say Don't Use a 100% Stock Portfolio
I find it interesting that the majority of those who advocate for a 100% stock portfolio are on the young side. When I talk to older investors, they are very much fans of bonds. Their willingness to take risk has dropped over the decades, of course, but part of it is that they have lived through economic scenarios that you and I have never seen. These older folks say “Pay off your mortgage” even though the numbers suggest you could come out ahead by not doing so. They say, “Own both stocks and bonds” even though they would have come out ahead with a 100% stock portfolio over their lifetime. Ignore the wisdom of your elders at your own peril.
Benjamin Graham, who Warren Buffett considers his mentor, said that you should never hold more than 75% of your portfolio in stocks and no more than 75% of your portfolio in bonds. Graham was born in 1894 and died in 1976, so his investment career really started during World War I, extended through the Great Depression and World War II, endured through the cold war, and ended during the stagflation of the 1970s. Stock yields were over 5% for most of his career (actually higher than bond yields) and that was felt to be normal since stocks were so much riskier than bonds. Taylor Larimore is a big fan of holding bonds and recommends you hold up to your age in bonds. He's 94 years old. You might consider what he knows that you don't.
Might want to find a less risky place to watch TV, never know what might land on you.
#6 Don't Take Investment Risks You Don't Have To
Some people may need a 100% stock portfolio to meet their goals. Some people may also need to highly leverage their lives by borrowing against the house in order to invest more. Others may need a highly leveraged real estate portfolio to get what they want. But the chances of you needing to do that to reach your goal are probably pretty low. A typical young attending physician reading this site simply doesn't need to take those kinds of risks to retire early as a multi-millionaire. At a certain point, you've got to ask yourself why you're taking risks you don't need to take. Is 24% more volatility worth it to retire in 29 years instead of 30? Would you be better off cutting back your lifestyle a tiny bit and working an occasional extra shift so you could save a little more money and use a 75/25 portfolio rather than a 100/0 portfolio? Probably. These aren't risks that folks like us need to take. Don't take risks you don't have to.
# 7 We Overestimate How Much the Future Will Resemble the Past
A common behavioral error is to expect that the future will resemble the past, particularly the recent past. We project what we have seen will continue indefinitely. A careful study of the past will reveal that time and time again investors are surprised when that isn't the case. How sure are you that stocks will outperform bonds over the next 30 years? How about the next 20? 10? Be careful that this very natural human tendency doesn't lead you to take on more risk than you should. In early 2000, people were really sure stocks would outperform bonds in the 2000s, but they were wrong.
There you go. If I haven't convinced you to add some bonds to your portfolio AND you've invested through your first bear market, feel free to use 100% stocks or more. But the Venn Diagram overlap of those who can tolerate a 100% stock portfolio and those who need to take that kind of risk is so small that the odds you're in that area of overlap are unlikely.
What do you think? Do you hold bonds? Why or why not? What percentage of investors do you think can tolerate a 100% stock portfolio in a down market? Comment below!
As always, great post.
Would you consider the “G Fund” in the Thrift Savings Plan to be a bond fund?
Yes.
Yes. Cash on steroids. Really, really safe bonds. Either way is fine to look at it.
An informative post. However, in considering whether a higher percentage stock portfolio is reasonable, you also need to consider portfolio size and income needs from that portfolio.
I am 60 years old and let’s assume retirement income need of $120,000 per year to comfortably retire. Let’s also assume that I and my spouse will receive $35,000 in Social Security benefits and have no debt; so, I will need about $85,000 per year of income from my retirement fund.
If I have $2,000,000 retirement fund, It would be imprudent to have a 100% stock portfolio as I would be at substantial risk in a stock market decline; having a large portion of that portfolio in bonds would be essential.
However, if I have a $15,000,000 portfolio, then this risk is not nearly as important as it is likely that I will never have to withdraw a substantial portion of a diversified stock portfolio; in fact, it is likely that I will never have to sell assets (and just withdraw dividends), even in a prolonged 40% slump.
Also in the current interest rate environment, bonds have a substantial interest rate risk as well as a credit risk. Bonds can loose money; although, there is less risk historically than stocks.
In addition, with all of the debt being accumulated by our government, I believe that there will be inflation risk in the future as well. TIPS are yielding around -1% lately; so that won’t be a good alternative.
If you have a $15,000,000 pot and only need to draw $85,000 yearly, it means you either worked too long or received a windfall. With those numbers, it makes no difference what you do. You could be 100% cash and never run out of money.
That’s kind of a narrow view of why we work (work only long enough to make money to retire) or why we want to grow investments (for personal consumption before we die). If your ambitions go beyond money in your career or you have ambitions in funding causes that have meaning for you there isn’t a set stopping point for your career or for attention to how to maximize your investment returns over an open-ended time horizon.
I think it’s great for people who have found a career they enjoy so much that they work until they are physically or mentally unable to.
My point is that at that level of wealth, it really makes no difference what your asset allocation is when you’re likely going to be dead within 20 to 30 years.
True. And that illustrates why a larger portfolio can be more flexible in how it is invested. But why should an individual not maximize returns, whether they plan on leaving the money to charity or something else?
Working longer than the minimum you had to work does not equal “worked too long.” There are many reasons people work, only one of which is to accumulate a larger nest egg.
The counterpoint is that in your first example ($2M needing $85K), the investor has a much greater need to take risk and in the second example ($15M needing $85K) the investor has much less need to take risk, even though he can afford to take a great deal.
Credit risk can be nearly eliminated by only using very high quality bonds. Interest rate risk is always there, you just think about it more when rates are low. But it’s just as easy for rates to go from 4% to 10% as from 1% to 7% and the damage/benefit is the same. Don’t forget that benefit either. If your investment time period is longer than your duration, rising rates are GOOD for your bonds, not bad for them.
The fact that TIPS are at -1% suggests that the market does agree with your assessment of future inflation.
Thanks for your comment.
Your counterpoint may be correct; but, my original comment was referring to the ABILITY to take risk with a larger portfolio and not the NEED to take risk. A higher value portfolio has a greater ability to deal with the added risk of a high stock market allocation from a risk standpoint. The likely (although not guaranteed) greater return of the stock market over long periods is more attractive if able to mitigate risk with a larger portfolio.
High quality bonds are less risky; but, they still have credit default risk. Remember the housing crisis in 2008 where many private MBS AAA and AA bonds lost much of their value? Government bonds are an option; however, when we look at the fiscal crisis in Greece from several years ago, government bonds declined more in value than private bonds. Is the reckless spending of our government leading us to the same situation? I don’t know; but, it needs to be considered.
I would respectfully disagree with your statement that interest rate risk is the same whether bonds are at 4% or 1%. When bonds are at 4%, you still have the chance that a decrease in interest rates from 4% will INCREASE the value of the bond (as they did over the past 15 years or so). You probably do not have same upside potential when interest rates are at 1%; so, you have upside potential at 4% where you don’t at 1%. That makes bonds at 4% a better investment given all other factors being equal.
I would also disagree with your comment about TIPS and inflation. Interest rates are mainly set be monetary policy and the Fed. Rates, in my opinion, have been set artificially low currently because of the COVID crisis and the need to stimulate the economy. Since TIPS are inflation protected, the base rate is more dependent on monetary policy rather than the concern of future inflation.
What happens if interest rates go negative? Or inflation becomes deflation. Still upside there. But we weren’t talking about upside, we were talking about downside.
The Fed mostly sets short term rates. The market sets the intermediate to long term rates. I agree that the fed has done all it can to artificially lower them.
Great points, John! The article is good, but John’s points are a great add-on. I know many in similar positions. They didn’t necessarily work too long, but accumulated more wealth (through work or investing) than they need. Nothing wrong with that.
They are now accumulating using 100% stock market (stock market risk is not an issue, as time horizon and needs make it moot.) The greater accumulation affords possible further opportunities for themselves, but also for charitable and inheritance purposes. Basic point: Not everyone should follow the same advice, but learn as much as you can and take all the advice you can get.
Joe
Great points. I hold 20% of my portfolio in bonds as my written plan calls for. I’ve gotten a handful of critiques for having that much of a bond allocation this early in my investing career (my plan is posted online) but I do it for all of the reasons you list. I just don’t see the need to take the risk of a 100% stock portfolio and also don’t know that stocks will always outperform. These 2 assumptions logically lead to the conclusion of having a bond allocation. And I think that those are 2 very safe assumptions for just about all high income earners, ESPECIALLY at the beginning of their investing career.
Thanks for the great post
To me the only valid argument here (for accumulation phase) is the risks of cashing out near the bottom, which is definitely a potentially devastating mistake. I prefer to avoid that with behavioral modification aka don’t look at the markets so you don’t feel the pain which has stood me in good stead through many hairy bears. The risks of cashing out when you’re young just aren’t that great because you don’t have much money yet and you have a lot of human capital and if you make that mistake then you’ll know you need to do something different moving forward.
Of course, some investors who are burned early in their investing career for taking on too much risk are so scarred from it they never get back into the market. So early screw-ups can have lingering effects that are far more important than the small amount of monetary loss would suggest.
Agreed, and I’ve never been convinced a small bond allocation is going to make the average person feel much better if the market does end up tanking. Assume a 50% drop in the stock market, starting with a $1M portfolio, you’d have $500k left at 100% equity and $550k left at 90/10 (of course bonds will likely see some increase in that case, just trying to keep the math simple). It’s going to be a devastating loss on paper, no matter what.
I agree that 90/10 isn’t that different from 100/0. But if you bump it down to 75/25, and bonds go up 5% while stocks drop 50%, then your $1M portfolio is about $638K, substantially more than $500K. Will it still hurt? Sure. Will it hurt less and perhaps help you stay the course and rebalance? Almost surely.
I have to admit that I am going against your advice here (and against the advice of wise investors like Rick Ferri or Bill Bernstein whom I respect). I don’t hold any bonds and don’t plan on adding them to my portfolio. I don’t think stocks are a bargain right now but bonds are at an extreme for which we don’t have good historical precedents. If you think of the proper function of bonds as providing safety so you choose government bonds (as I think you mentioned in your interview with Larry Swedroe) you can’t point to any time when bonds have been at lower nominal coupon rates. The only time the US was at a similar debt-to-gdp ratio (just after World War II) bond rates were suppressed below the rate of inflation, government policies encouraged inflation which helped decrease the debt-to-gdp ratio and limited capital flows outside the US. During the decade of the 1950’s 10 year treasurys returned a total of around 8% (not annual, over the whole decade, see for instance: https://www.researchgate.net/profile/Mark_Schaub2/publication/341458838_Stock_Market_Returns_by_Decade_An_Illustration_of_Risk_and_Return_in_Equities/links/5ec28615299bf1c09ac4e44f/Stock-Market-Returns-by-Decade-An-Illustration-of-Risk-and-Return-in-Equities.pdf?origin=publication_detail). None of our tables on returns for mixes of equity:bond portfolios include starting points where safe bonds are this expensive or central bank balance sheets are at these extremes. I don’t think stocks are a bargain but I worry that bonds have lost much or all of their ability to really balance risks.
No doubt I could be wrong, so I try to lower risk by having no debt, owning our homes without any debt and having an emergency fund that could cover expenses for several years. Also because we over-saved our dividend income is about three times our yearly expenses, but I just can’t see buying 10 year Treasurys that yield under 1% in part because the Fed has purchased almost all of the new US government debt issued this year (http://www.crfb.org/blogs/fed-buying-our-new-debt). There are only a few times stocks have been as expensive as they are today but nothing comes close to the current circumstances for government debt.
Everything you’re saying about likely future bond returns as of right now also applies to stocks, real estate, and just about everything else. When interest rates are low, people flee bonds into stocks, jacking up stock prices and lowering future returns on those stocks. Low interest rates increase the value of properties (since it is easier to borrow to buy them), lowering their future returns. So people flee into gold, or Bitcoin, or whatever. There is no safe haven from the effects of low interest rates on future returns.
I agree with your plan to dump your debt and save more though. Those are great choices when you expect lower future returns on your investments.
I agree that all of these assets are expensive but despite the expectation that people are fleeing bonds for higher risk assets look at how lopsided fund flows have been into bonds over stocks this year:
https://i1.wp.com/lplresearch.com/wp-content/uploads/2020/07/7.14.20-Blog-Chart-1.png?ssl=1
https://www.marketwatch.com/story/investors-are-fleeing-to-bond-funds-and-thats-good-news-for-stocks-2020-06-09
I agree with you 100%. Bonds have absolutely no direction to go but down in price. If you have experience with not panic-selling during a bear market or stock market crash, then it makes perfect sense to forgo the certain loss in bonds and ride out stocks. I am doing the same thing and am 52 years old.
Maybe. Maybe not. Better to lose 5% in bonds than 40% in stocks. You can really only know the right thing to do in retrospect.
Thanks for making me feel so old. I have been recommending paying off debt and owning bonds for decades!
They have “smoothed my ride” and provided me an upside in market panics.
I still like the old fashioned Jack Bogle “age in bonds.” As a starting point at least.
Dave Ramsey talks a lot about being realistic with emotions and behaviors and not just math. He applies that to his advantage with paying of debt as a snowball. But then he recommends we all invest 100% in stocks. That ignores the emotional panic that we humans feel in crisis.
Diversification is a powerful tool.
Temporary 100% stock investor here with a question about my reasoning:
I’m just starting second year of surgery attending with massive (over $800k between spouse in fellowship and myself), private student loan debt. I’m currently 100% equity but only because my savings are 403b and backdoor roth IRA x 2 with everything else (~100k this year) to loans. My investment plan calls for me to get to 20% bonds and I have tentatively given myself until 2022 to get closer to my ideal asset allocation. My reasoning is that by then (with my wife starting to make closer to what she’s worth) we will be easily maxing out retirement accounts and likely be opening a taxable account for the bonds (yeah I said it…). I would like to re-balance with new investments and really adhere to a buy and hold strategy. There are so many other moving parts to anyone’s investment choices that there is no one size fits all answer but I feel that my being 100% equity for a year or two at the very beginning shouldn’t worry me too much. I’ll just let my other hobbies distract me from the percentages until they are closer to “ideal”. Am I crazy or does this reasoning make sense?
Love love love this site, podcast, forum, etc… Thanks for everything!
Certainly loans are the equivalent of a negative bond, so putting money toward debt increases your net worth in a similar way to owning bonds that yield the same as the interest rate on your debt. In reality, you’re at something like 800% stocks, so going to 700% stocks this year by paying off loans is getting less aggressive, even without bonds.
The only possible concern in your scenario is whether you’ll panic in a market downturn due to your 100% stock allocation. I hope you can avoid doing that.
Your plan sounds good to me–just stick to it.
Another great post Jim. You can take the argument one further and question whether you should invest all that money you spend on pesky insurance premiums for claims you’re unlikely to ever make.
Sorry James K, that comment was not meant for your post (accidental placement), more of a general comment for the article. My bad.
My 20% bond allocation certainly helped me sleep at night earlier this year when I was abruptly not working for over a month due to COVID and had very little income. Never thought I’d see a situation where job security as a doctor was in question, but there it was.
This reminder that sometimes the market is horrible for many years, especially in countries without the US’s 20th century prosperity and stability, is a little grim. I appreciated your recent market timing post and decided that for us ‘keep your powder dry’ should mean we have bond/ cash equivalents to move/ survive without dividends or stock sales for 3 years while adjusting our lifestyle downwards if the market contracts for a while or I lose income through widowhood, rather than be ready to market time in a downturn.
/Warning crazy TEOTWAKI (the end of the world as we know it) talk/
But the US could possibly be leaving the 20th century’s stability- some people thinking this will only happen if their party loses, on both sides. Covid is a big enough cause without considering elections. You younger docs need to keep cash on hand (perhaps just in the form of emergency funds and good disability and life insurance) in case of a job loss/ disability or drop in income such as Covid produced for some of us, and more slowly as medical corporatization has diverted medical profits to CEOs and away from private practice docs. However even us near retirees would be in trouble (not bad enough to need rifles and compasses) if the US stopped doing COI on our government pensions and we had runaway 1950s Germany style inflation. That would be a bad time for me to hope we could start living off of 3-4% of our stock investments if we were near 100% in stocks.
Diversifying helps- but what if the whole world has a bad 30 years? Know of any extraplanetary index funds?
OMG “extraplanetary” funds….i cant stop laughing
It will happen.
There is already an ARK fund that invests in commercial space companies. ARKX
😉
I’ve been 100% stock for years, including through multiple downturns. For me, it’s the correct choice and the large drops both in terms of % and absolute dollars (e.g., .com, 2009 and March of this year) don’t really bother me that much. With bonds at near zero rates, there’s no reason to think that bonds will provide much of a return on a going-forward basis. Will they outperform stocks over a meaningful period of time? Perhaps . . . if we have a Japan-like lost generation for stock. I’m willing to take that risk. And my stock holdings are all held in a globally diversified index portfolio, so that should help cushion things a bit in such a scenario.
I also don’t like the downside risk for bonds right now in the event interest rates increase, which seems likely at some point. Direct ownership of the bonds themselves could help mitigate this risk, however.
It all depends on where you are in life. There’s the whole concept of Target Date Funds (TDFs) and glidepaths and they start with a high equity share for a reason. Young investors SHOULD use mostly stocks. True, TDFs normally start with “only” 90% stocks, but if you work out the math you’ll see that 100% (and more if unconstrained by borrowing limits) is actually the desirable allocation. But TDF providers have to set it a bit below. Legal cover, CYA.
But once people get older, they definitely have to shift to diversifying assets. Especially around retirement. The Venn Diagram applies to this group: you don’t need 100% stocks and wouldn’t be able to handle the volatility either. Actually, the only retirees I know that CAN handle the vol of a 100% equity portfolio are successful FIRE bloggers with enough income from their blog.
Do you think this advice should apply to 529’s? We recently added 529’s to our portfolio for our two young children (3 and 9 months) with the intent that these will partially cover college expenses (also stashing money elsewhere and assuming that some portion of the over 4k a month we currently pay for daycare will able to be used for college once we are there). We’ve had better success establishing our own allocations in retirement funds rather than using target date funds and are doing the same for the 529s. Most things I have read on 529 investing recommend 100% stocks for the first few years of the funds (3-5 depending on the source), and then slowly changing the allocation as you get closer to freshman year. However, after reading this post I’m wondering if there are downsides I’m not appreciating to this strategy.
Well, some of it does. If you panic with you 100% stock 529 and sell low, you’ll wish you had more bonds. But I’m an advocate of investing pretty aggressively in a 529. My kids’ are not only 100% stock, they’re 50% SV. Hasn’t worked out very well of course.
https://www.whitecoatinvestor.com/3-reasons-why-you-can-take-more-risk-with-a-529/
Remember this post doesn’t say you HAVE to have bonds. It says if you choose a 100% stock portfolio at least do yourself the favor of understanding the opposing arguments.
I have been contributing to my kids 529 since they were born (now 14 and 12 YO respectively). My AA choice/glidepath for contributions is: 0 – 5 YO- 100% equities, 5 – 10 YO- 75% equities/25% bonds, 10 – 18 YO- 50% equities/ 50% bonds, college: cash. Currently, the AA is about 25% in bonds, which will pay a year plus for in state school and a year for a reasonable out of state school. Is this the right choice, I don’t know.
As Buffett says when the tide goes out you will see who’s swimming without trunks
No reason to be 100% stocks
In March many many people panicked and dumped all their stocks
I think your instincts about dry powder are, unsurprisingly, right on. There was a lot of dry powder talk back in March ’20…”so glad I’ve been holding 100K cash while waiting for this 15% drop.”
It absolutely is a psychological crutch, and the tactic holds no water when compared against historical back tests. It was great fodder for writing a few articles 🙂
This and the “Dry Powder” one a couple days ago… Timely posts this week, WCI! I think some of the confusion is also rooted in misunderstanding bond funds–what they’re for and how they actually work. “Bonds are for stability,” I’ve heard it said before. And there is more to a fixed income ETF or mutual fund than a headline about interest rates being low.
“You are far better off holding a 60/40 portfolio for decades than a 100% stock portfolio that you sell low just once during your investing career.”
Is there data that backs up this statement? I think it would entirely depend on “how low” you sell and “how much” you sell, otherwise I don’t see how this could be true given the other data that shows that stocks outperform bonds.
Okay, run the numbers of what happens when a 60 year old sells low during a pandemic or a global financial crisis. Then compare it to the returns of a 60/40 versus a 100/0 portfolio. You might be surprised. Remember we’re talking about losing 40-50% of a portfolio here. It’s a major financial catastrophe that must be avoided. Could easily be a 7 figure amount.
At your advice I ran some numbers. Assumptions: $1M start, 50 year old, 4% withdrawal increased by 3.25% each year for inflation, using 8.7% average return for 60-40 and 10.1% average return for 100-0.
After year 10 (age 60), reduce the 100-0 portfolio by 40% and the 60-40 portfolio by 24% (assume only stocks are impacted by the downturn). You’re absolutely correct – if no other changes are made, the portfolio value for the 100-0 allocation would be lower going forward – 10% lower at the start and 20% lower by age 80.
If the reduction to stocks is 25%, the two portfolios basically break even.
There are obviously faults in doing a simple model like this.
I also did a quick model of it in FIRECalc using a lump sum reduction to the portfolio in 10 years – 63% success for 100-0 vs 72% for 60-40.
Thanks for the thought exercise.
Yea, selling low is a huge financial catastrophe. It’s really important not to do it. And if being 90/10 instead of 100/0 helps you do that, it’s definitely worth it.
Jim, the chart you provide at the beginning of the post, while accurate, is very misleading. There’s no way that a 0/100 allocation is going to return 5.4% for a long time going forward. Bonds are expected to lose money on a real basis for at least the next decade. As such, the return differences between 100/0 and the other allocations should not be presented as being in any way helpful for determining one’s allocation going forward because they aren’t.
It’s only misleading if someone mistakenly believes that past returns indicate future returns. I expect my readers to be smarter than that.
I disagree with your assertion that bonds are expected to lose money on a real basis over the next decade. That’s opinion, not fact. Maybe we’ll have deflation and that’s why interest rates are so low. Maybe we’ll have no inflation and even a 1-3% nominal return will provide a positive real return.
Why did you present the table if not as an indication of what’s plausible? 5.4% nominal returns on bonds are completely implausible for a long time into the future.
And no, it’s not my opinion. It’s the market’s view. The 10 year breakeven inflation rate on Treasuries and TIPS is 1.75% (and the Federal Reserve’s target is 2%). The SEC yield on Vanguard’s VBILX is 1.06%. That’s an expected real return of -.69% annually. If you disagree with that, perhaps you should become a bond hedge fund manager.
I don’t have issues with the table itself since it’s referencing historical return data (although oddly, most return numbers in the table are .1% higher than the source data referenced – with a notable exception of the 100% stock allocation). But I have the same concern about not including current known bond returns in the analysis. It gets worse if/when you consider taxes on the return.
Might be the date it was accessed. This post was written some time ago.
It’s really hard to predict the future, but it sure would make my posts more interesting if I could.
My crystal ball is cloudy. So it’s really hard to present a table of future returns. I also have no idea what future inflation or future interest rates will be. If you do (especially to two decimal places), I would suggest submitting a guest post:
https://www.whitecoatinvestor.com/contact/guest-post-policy/
Readers would be very interested.
Every time I read an article like this, I am tempted to change my plan. Either I’m tempted to buy more bonds like this one, or I’m tempted to go into more small cap value, or I’m tempted to do something else (TSLA? Bitcoin? Rich Person Roth?).
Ultimately, I’m going to stick with my plan, which calls for staying in stocks for the next ten years, and then getting into bonds slowly through retirement.
Very insightful post and I savor every one’s comments! Currently paying off my 230k loans and, last I checked, keeping my mix at 80/20. I agree with the majority, will increase bonds closer to retirement and don’t take on more risk than necessary!
@Jenn, that TEOTWAKI line had me rollin” 😂 humor always appreciated!
@Rose – we were in rural Texas for Y2K ie January 1, 2000. We were very restrained compared to our friends: we only purchased our first grown up firearms and stored provisions, including a closet full of coffee and hard liquor for trading. (We don’t drink either, but we figured we could use alcohol to sterilize for surgeries, and both in trade. Refused to keep tobacco on principle.) We had friends storing gasoline, gold bars, cash, etc. My dog’s boarding kennel owner; a lean, chain-smoking, horsewoman; told me between drags she would ride over to my place and give me a horse so I could continue doctoring, and then she would ride off into the wilderness to get away from everyone. And when we moved that summer we tipped the moving guys with the closet full of booze, and friends bought our pickup 15,000 cash. An amusing anecdote now, and my grain grinder still works though we have never operated it manually. I only wish the pandemic had been such a false alarm.
I have 1 year of living expenses set aside as a emergency fund. The rest are in 100% globally diversified equity portfolio, 50% of which are in AVUV, AVDV, AVEM. For me, I treat investing like a game. My goal is to achieve the maximal rate of return and beat “the market”. Only time will tell if factor-tilted investing will prove to be successful. I don’t have the guts (or whichever male body part you choose) to use leverage, so 100% equity made sense for me. When I am managing my portfolio, I treat it as if I am managing someone else’s money, to avoid letting emotions getting in the way.
Thanks for this interesting post!
Surprised you’re willing to play games with your serious money. I’m not.
I would suggest refining your goal from beating the market/maximizing return to actually achieving your financial goals. I consider investing a one player game, you against your goals.
Jim, great post as always!!!
I wonder if you think that I fit all your criteria to be 100% in stocks. I found that with an 80/20 AA that I lost sleep because stock didn’t fall even more! and the bear didn’t last that long at all!!! WTF!!! anyway, being 39, wife being 40, both of us being docs, and having gone through this bear market with my reaction stated above, seems my risk tolerance and risk capacity is super high, so I changed to 100% equity AA. It’s 65% total US, 10% small cap value, and 25% total international, so at least with the international in there I am protecting myself a bit from a Japan type scenario. And I still have student loan debt and a mortgage, so I guess I’m 130% stocks. also, I don’t go 100% small cap value b/c as you mentioned because as Rick Ferri and Paul Merriman mentioned in your podcast, might need another 100 years of data to solidify that small and value have a premium. Finally the need to take more risk is substantiated by wifey coming home from call just 10min ago, me telling her how badly my son did in school paying attention, yelling that she wants to quit and that our son’s ADHD is a result of poor parenting b/c we are always working, and threatening to quit tomorrow. 100% equities won’t accomplish that tomorrow, but at least sooner rather than later.
So do we fit the 100% stock criteria?
I know how you feel. I was really disappointed that I didn’t manage to invest any money in March anywhere near the bottom. My March investments went in two weeks before the bottom and my April investments went in two weeks after! I did manage to tax loss harvest right at the bottom though.
Sounds like you can tolerate 100% stocks emotionally anyway, but take a look at the other reasons too before committing to that portfolio.
There is increased downside risk as well when interest rates are low.
If rates go from 1% to 7%, an infinite term bond loses 85% of its value. If the rate goes from 4% to 10% it loses only 60% its value. Obviously a fixed term bond would have less loss; but, the proportion of loss between each scenario is the same.
So, in a low interest rate environment, bonds have more downside risk with a fixed increase in interest rates than in a higher interest environment.
I generally recommend against infinite term bonds. 🙂 I prefer short to intermediate, which is a lot less than infinity.
But your analysis is short-sighted. Once you hit the duration (5 year duration for example), a bond investor comes out ahead with higher interest rates.
An important reason that you give for not having a 100% stock portfolio is that such a portfolio increases risk because it is less diversified.
But another way to manage risk is growth. All other things being equal, a portfolio that has grown more over then last 10 years will have less risk than one than has grown less.
The following extreme example illustrates the point. If I lose 99.9% of my net worth, I’m wiped out. If Warren Buffet loses 99.9% of his net worth, he’s worth about $80 million.
The counterpoint is that all other things are not equal, and that’s valid. But growth as a risk management tool probably doesn’t get the attention it deserves.
I don’t understand the hype in small cap value. When I look through the Vanguard stable of funds, they’d done poorly compared to large growth over YTD, 1, 3, 5 10 year periods. I can’t afford to take such big hits on my portfolio year after year waiting for them to show their stuff. In fact the best performing stock funds in all of Vanguard over those periods are the large growths. Granted, I may have an itchier trigger finger than most, but large growth over the past decade they have done very well for me. What am I missing?
Paul Merriman has a graph that plots the ratio between the S&P 500 and his 4-fund combo, which consists of US Large Blend, US Large Value, US Small Blend, and US Small Value. It shows that the value premium has long periods where it doesn’t show up and a small number of periods where it does show up. So, a value investor needs to think in terms of multiple decades for the value premium to show up.
https://paulmerriman.com/wp-content/uploads/2020/09/US4F-vs-SP-500-Telltale-Chart-1930-2019_Page_6.jpg
It’s anybody’s guess if it will continue in the future.
If you only go back 10 years, I’m not surprised you don’t understand the hype. They’ve underperformed over the last 10 years. Luckily, I own all the large growth stocks too.
I only went back 10 years because that’s only as far back as Vanguard goes on their site.
In the past you could have actually outperformed a 100% stock portfolio with half the volatility using a 60/40 portfolio of stocks and Extended Duration U.S. Treasury STRIPS (EDV). In order to outperform 100% stock portfolio, it is very important that you rebalance when your asset allocation deviates 1% from 60/40.
https://portfoliotoolbox.com/backtest-portfolio.html?args=%7B%22alloc%22:%7B%22VTI%22:%5B100,60%5D,%22EDV%22:%5B0,40%5D%7D,%22checked%22:%7B%22VTI%22:true,%22EDV%22:true%7D,%22dividends%22:%7B%7D,%22portfolio%22:%5B%22100%25%20Stocks%22,%2260/40%20Extended%20Treasuries%22%5D,%22rebalance%22:%5B0,1%5D,%22units%22:%5B%22n%22,%22%25%22%5D,%22minrange%22:false,%22initial%22:10000,%22start%22:13907,%22logscale%22:false%7D
That’s a very low rebalancing threshold, pretty impractical really, and obviously the dramatic performance of STRIPS is due to the incredible drop in interest rates over the last 40 years, which is obviously not reproducible from today’s date.
Ric Ferri suggests 30/70 in retirement as the center of gravity