The switch from growing wealth to preserving it has slowed down – and that’s not good for our lengthening retirements.
Many financial planners now recommend investing a percentage equal to 20 less than your age in bonds and the remainder in stocks.
Under this new advice, a 60-year-old who is relying on this income should have 40% of their portfolio invested in bonds and 60% invested in stocks. An 80-year-old should now have 60% of their wealth invested in bonds and 40% invested in stocks.
Under this guidance, many Americans have too little of their net portfolio in bonds.
That could prove to be quite dangerous.
All bull markets eventually run out of steam. When that happens, investors without the proper stock-to-bond allocation are going to see their net worth tumble a whole lot more than it should.
That’s because bonds tend to hold up well when stocks perform poorly. The financial crisis is a great example.
In 2008, the S&P 500 plummeted 37%. During that same time frame, the Bloomberg Barclays US Aggregate Bond Index gained 5.2%.
Could your retirement fund withstand a 37% hit? If you’re like most Americans, your answer is “probably not.”
Or take the COVID-19 crash earlier this year…
When the S&P 500 bottomed on March 23, down by more than 30% since the end of 2019, the bond index was actually up by more than 1% for the year. The chart of the total return for both is below.
As the S&P began to plummet, the Bloomberg Barclays US Aggregate Bond Index actually started to rise. And the loss it did face during the downturn was miniscule compared with the devastation that hit the S&P.
That’s why bonds and asset allocation are so important.
Bonds do a nice job of preserving wealth when the stock market heads south. The income they generate is also a nice bonus.
Bonds play an important role in portfolio diversification – but there’s no right or wrong number for your portfolio’s allocation. It’s important to find a balance that works for you.
Investors with a lower tolerance for stock market risk might want to invest a larger-than-recommended percentage of their portfolio in bonds. On the other hand, if they have a higher risk tolerance, they might want bonds to make up a lower percentage of their portfolio.
But either way, don’t avoid bonds altogether.