Fredrickson Financial

Should you go all in on stocks?

October 25th, 2016

I have had a few clients recently ask me about the wisdom of having a retirement portfolio that is 100 percent invested in stocks based on the following two-part article published in the New York Times.

http://www.nytimes.com/2016/02/06/your-money/why-your-portfolio-needs-plenty-of-stocks-whatever-your-age.html

http://www.nytimes.com/2016/02/13/your-money/how-much-of-your-nest-egg-to-put-into-stocks-all-of-it.html

The article makes the point that stocks virtually always outperform bonds by a wide margin over lengthy periods of times so maybe people should have all of their investments in stock.

First of all, while the articles point out that Warren Buffett subscribes to this view, that is hardly a rationale that applies to the rest of us. What may work for one of the richest men in the world could misfire when applied by normal people.

Second, the argument is based on a fallacy. It takes the returns of stocks and bonds and says, hey, look stocks are much better, therefore you should put all of your money in stocks and forget about bonds.

The reality is that the returns of stocks are often inversely related to those of bonds. Bonds will tend to go up when stocks go down and vice versa.

As a result of this tendency for asset classes to behave differently, a blended portfolio is more than the sum of its parts.  Taking the individual parts and comparing their returns is wrongheaded since the blended return in any given year will tend to be higher than the annual average of the asset returns considered individually.

This is the essence of modern portfolio theory. The goal is to maximize your return for a given level of risk.

It’s true that stocks go up more often and further than bonds, so it makes sense for most people to have more stocks than bonds. But a lot of folks can’t handle the volatility of an all-stock portfolio, as the writer points out, and again, you are not giving up as much the article claims by having some bonds in your portfolio, as can be seen from this graphic: https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations.

Bottom line, it’s a case-by-case thing, but bonds are not what you should be afraid of this October.

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