One of the shortest routes between here and being broke in your 80s is ignoring one of the least understood aspects of all asset allocation models: bonds.
Since March 1991, I have been standing in front of groups talking about them, writing about them, pounding the table about them and, at times, begging people to add them to their portfolios. I’m sad to say I have been painfully unsuccessful.
Based on my almost 30 years of experience, despite our increasing ages, which dictate we must increase the percentage of bonds we hold to reduce volatility, I guesstimate 8 out of 10 people hold few to none.
What makes this so difficult to understand is that, without exception, every asset allocation model I have ever seen requires bonds. But the only thing people ever seem to see are the cash and stock parts of the pie charts.
Irrespective of age, almost no one holds the required minimum percentage of bonds.
If you follow my work here or in The Oxford Income Letter, you should know that almost every asset allocation model’s required percentage of bonds is too low. That’s because they assume a fixed percentage of bonds and lower-risk investments work for everyone – a one-size-fits-all approach.
Like I’ve explained many times, as our ability to assume risk declines with age, the percentage of low-risk holdings like bonds has to increase, not remain fixed.
And this absence of low-volatility investments in our portfolios is creating a dangerous, expensive, long-term problem.
We have an approaching retirement and retired population who, for the most part, pick and choose which parts of their allocation models they fill. And, in my experience, these people hold only stocks and cash.
This limited and improvised diversification results in increased risk, and as we age, that risk continues to worsen because our ability to assume it decreases annually.
If our risk tolerance decreases but the ratios of stocks to bonds remain fixed in our portfolios, the risk levels of our holdings skyrocket.
There aren’t many absolutes about the market, but there are a few:
- Risk drives losses – losses we, the gray hairs of the world, have no way of replacing.
- Asset allocation models were never developed as a “one from column A, two from column B” planning tool. It is an all-or-nothing system.
- If you don’t reduce your risk level as you age, you will lose.
They aren’t as exciting as stocks, and you’ll probably never have a three- or four-bagger, but the right bonds offer security and safety you can’t get anywhere else.
And it is security, reliability and predictable returns that we need at this point in our lives, not the thrills of the stock market.
If you’re over the age of 55 and you aren’t ratcheting your risk tolerance down once a year, you’re sticking your neck way, way out there.