Find Out What Your Investment Might Look Like Based on Your Stock-to-Bond Ratio
When markets become volatile, people start to wonder if they should sell their stocks or put more money in bonds. Before you make your next investment decision, it’s worth looking at how the stock-to-bond ratio has changed over time, understanding, of course, the often repeated investment phrase: “past performance is not a guarantee of future performance”.
However, Financial Samurai has an excellent summary of how the various investment breakdowns have historically come about. If, for example, you went all-in with bonds, you can expect your portfolio to outpace inflation:
0% stocks and 100% bonds have provided an average annual return of 5.4% since 1926, outstripping inflation by about 3% per year.
However, if you put 80% of your investment in stocks and 20% in bonds (perhaps the classic Boglehead portfolio of three funds), you can expect higher annual returns and much more ups and downs:
80% of stocks and 20% of bonds provided an average annual return of 9.5%, worst year -34.9% and best year + 45.4%.
Use financial samurai analysis to learn more about what to expect from different types of portfolios. Then ask yourself what volatility you can handle in exchange for potentially higher returns (with more risk of loss, assuming you cannot stay in the market until it recovers again).
Many financial advisors recommend weighing your stock portfolio when you are younger and gradually investing more money in bonds as you age. This allows you to take advantage of a rising market during a period when there is still plenty of time to recover from a market loss, and move your investments to less volatile assets when there is not much time to recoup after an unexpected market downturn.
If you sign up with a fund with a set date or lifecycle, your portfolio will automatically shift towards a higher bond allocation as the fund approaches its target date – although it’s worth noting that some financial advisors are not fans of these types of funds as they can include high cost ratios.
Ultimately, the best and most daunting thing about investing is that you decide where to put your money, so it’s worth learning as much as you can about what can happen when you split your investment between stocks and bonds, and how you want to. manage and adjust this distribution over time.