Example, bonds vs stocks

Example, bonds vs stocks

The single most important decision an investor can make is the allocation between stocks and bonds. Based on a vast amount of historical data, we know how different allocations between stocks and bonds behave over long periods of time.

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Vanguard offers data on the historical risk and return of various portfolio allocation models based on data from 1926 to 2018. For example, a portfolio consisting of 100% bonds has experienced an average annual return of 5.3%. Its best year, 1982, saw a return of 32.6%. It fell 8.1% in its worst year, 1969. Of the 93 years of historical data cited by Vanguard, a 100% bond portfolio lost value in 14 of those years.

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At the other extreme, a 100% stock portfolio had an average annual return of 10.1%. Its best year, 1933, saw a 54.2% return. Its worst year, just two years earlier in 1931, experienced a decline of 43.1%. The portfolio lost value in 26 of the 93 years covered by Vanguard’s analysis.

Comparing these two extreme portfolios underscores the pros and cons of both stock and bond investments. Stocks over the long term have a much higher return, but the stock-only portfolio experienced significantly more volatility. The decision investors need to make is how much volatility they can stomach, while also considering the returns they need to meet their financial goals.

Income, Balanced and Growth Asset Allocation Models

We can divide asset allocation models into three broad groups:

  • Income Portfolio: 70% to 100% in bonds.
  • Balanced Portfolio: 40% to 60% in stocks.
  • Growth Portfolio: 70% to 100% in stocks.

For long-term retirement investors, a growth portfolio is generally recommended. Whatever asset allocation model you choose, you need to decide how to implement it. [1]