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Stocks vs Bonds - How Much Should You Invest in Stocks vs Bonds

In a previous article we examined whether stocks are riskier than bonds, concluding that they are, but it is also a function of how you hold bonds, whether individual bonds or bond funds. Given that there is a tradeoff of risk between stocks and bonds, the natural question to ask next is how much you should invest in stocks versus bonds. For example, the conventional wisdom is that it should be a function of your age, as we expect your appetite for risk to diminish over time.

The conventional rule of thumb is to allocate a percentage of your portfolio equal to 100 minus your age to equity stocks holdings, with the rest in bonds. For example, if you were 55, then you should hold 100 - 55 = 45 or 45 percent of your portfolio in stocks, and 55 percent in bonds.

However, this strategy is designed to reduce risk at the expense of overall return. But most investment advice really doesn’t center on having a reduced yield over time. So what it a good strategy to balance your stock and bond holdings if your expectation is to have a consistent return from your investments.

In that case, it’s more likely that you will want to optimize the risk/ reward ratio. If you use that as the basic yardstick for your investment strategy, then a static allocation percentage of stocks vs bonds will give you that best risk vs reward. Most generally that is accepted to be 40 % bonds, 60% in equity stocks. Here’s an article that describes a more diversified portfolio if you want to reduce risk even more, at the expense of a few more holdings.

The bottom line is that as you look to diversify your holdings between stocks and bonds, a static allocation is likely your best bet. But understand that you can do better than a simple 2 fund allocation, and the reality is an active fund selection process will likely outperform even a more diversified 4 or 6 fund allocation as well.

Filed under Asset Allocation

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