Recs

3

Is Your Portfolio Too Stock-Heavy?

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

When the stock market was booming, having anything less than 100% of your assets invested in equities felt like you were simply leaving free money on the table. But now that stocks have seen the bottom fall out of the market, many people have started asking the question they should have considered all along: Will a more conservative asset allocation still let you meet your long-term financial goals?

A recent article in the Wall Street Journal suggests that the answer is a resounding yes. Independent research based on past performance figures shows that a 50/50 allocation between stocks and long-term Treasury bonds has historically yielded returns that aren't much lower than those from a more aggressive 80/20 mix of stocks and bonds. The more conservative allocation, however, has had a lot fewer bumps along the way.

To shell-shocked investors who've seen their portfolios lose a lot of value this year, the idea of an asset allocation that would have helped them avoid a big part of those losses couldn't be more appealing. Could it really be as simple as buying more bonds?

Timely research
Before you cut back on stocks, take a closer look at the study's methods. To its credit, the study attempts to measure a full cycle, starting at the bottom of the 1987 crash. Nevertheless, the events of the last two months prove to make a big difference in its results.

To show you just how big a difference it makes, take a closer look at the return figures. According to the study, a 50/50 mix had a 10% average return, versus 10.3% for the 80/20 mix. That amounts to a total return over those 21 years of roughly 640% for the 50/50 portfolio and 684% for the 80/20 portfolio.

Consider, though: just two months earlier, the Dow was nearly 25% higher than it was by the end of October, the study's end date. Bond prices, on the other hand, moved down by about 1% from August to October. So if you had measured total return just two months earlier, you would have gotten a much wider disparity -- 830% of total return for the 80/20 portfolio, versus just 723% for the 50/50 mix. That equates to 11.3% annually versus 10.6% -- a margin that's over twice as big.

Doing what it takes
Admittedly, even that larger difference doesn't sound like a whole lot to gain, compared to the added risk that you take on. As the study points out, the 50/50 mix would only have lost about 15% in the past year, versus a 25% drop for the 80/20 portfolio.

After the fact, it's easy to argue about whether you would've been better off with a more aggressive or a more conservative allocation. The tougher question, though, is how you're supposed to set yourself up going forward. As we've seen recently, history is an imperfect guide to what you should expect from the stock market.

Picking an allocation is only part of the puzzle. In addition, you have to consider the following:

  • How much you contribute. If you can save a huge percentage of your income, then you won't have to be as aggressive to reach a certain savings goal as you would if you can only save a more modest amount.
  • Types of stocks. Historically, small-cap stocks like Gentiva Health Services (Nasdaq: GTIV  ) and Eagle Test Systems (Nasdaq: EGLT  ) have had higher long-term returns as a group than more established large-cap stocks such as Pfizer (NYSE: PFE  ) and Intel (Nasdaq: INTC  ) . Investing in those higher-return, higher-volatility stocks also increases your risk, though, potentially making a higher bond allocation more attractive to help even out the bumps.
  • How much time you have. As you get close to retirement, you don't have the time to ride out long-term declines in the stock market. That makes a more conservative allocation more attractive as you get older.
  • Income needs. In today's upside-down market, many stocks, including General Electric (NYSE: GE  ) , Merck (NYSE: MRK  ) , and Dow Chemical (NYSE: DOW  ) , have income yields far in excess of what you'll get from Treasury bonds. If you need current income, a big stock allocation may actually get you more money than a higher allocation to bonds.

Once you have a plan, the most important thing is sticking with it. If you go with an 80/20 allocation when the markets are trading near highs and switch to a 50/50 allocation after you've lost a bundle, you'll get the worst of both worlds.

Being aware of risk is an essential part of successful investing. If your risk tolerance makes a more conservative allocation easier to handle, then it's definitely worth considering -- once stocks recover from bargain-basement levels.

Here's more on making the right moves in your portfolio:

Setting up a smart allocation is just one of the ways our Rule Your Retirement newsletter can help you. Every month, you'll get tips on promising investments, setting up a plan you can live with, and setting realistic goals that will ensure your comfort in your golden years. Best of all, you can take a look absolutely free with a 30-day trial.

Fool contributor Dan Caplinger has a well-diversified portfolio. He owns shares of General Electric. Pfizer and Dow Chemical are Motley Fool Income Investor picks. The Fool owns shares of Pfizer and Intel, which are Motley Fool Inside Value selections. The fool also owns covered calls in Intel. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy doesn't cut corners.


Read/Post Comments (2) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 19, 2008, at 4:10 PM, sidinsd wrote:

    Now you tell us! Why didn't you write this article at the beginning of the year before my stock portfolio lost 2/3 of its value? If I sell now and convert to 50% T-bills, I'd be converting nothing, and 10% of nothing is still nothing. I just have to hold on for 25 years, by which time I'll be dead, and hope my stocks come back.

  • Report this Comment On November 19, 2008, at 10:22 PM, dividendgrowth wrote:

    FOOLS always sell at bottoms.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 779288, ~/Articles/ArticleHandler.aspx, 12/21/2014 10:24:14 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

Today's Market

updated 1 day ago Sponsored by:
DOW 17,804.80 26.65 0.15%
S&P 500 2,070.65 9.42 0.46%
NASD 4,765.38 16.98 0.36%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/19/2014 4:02 PM
DOW $45.84 Up +0.36 +0.79%
The Dow Chemical C… CAPS Rating: ****
EGLT.DL2 $15.55 Down +0.00 +0.00%
Eagle Test Systems… CAPS Rating: ****
GE $25.62 Up +0.48 +1.91%
General Electric C… CAPS Rating: ****
GTIV $19.05 Down -0.10 -0.52%
Gentiva Health Ser… CAPS Rating: ***
INTC $36.37 Down -0.65 -1.76%
Intel CAPS Rating: ****
MRK $59.58 Up +0.60 +1.02%
Merck & Co., Inc. CAPS Rating: ****
PFE $31.94 Down -0.03 -0.09%
Pfizer CAPS Rating: ****

Advertisement