Investing Guide asks should young people carry bonds in their portfolio?” This is question that I have mulled over before as well. I agree with Loi that “there have been some conflicting advice on whether young people should have bonds in their portfolio.” Personally I have been through one bear market already (without any fixed income) and I do not want to go through another one without bonds in my portfolio. Some of you will know what I mean. Others will not know the agony of seeing your portfolio’s value fall month after month as the stock market tanks. However, “having some bonds (15-20%) in a portfolio lowers downside risk by a large amount.” This is one of the key reasons that I want to have some bonds in my portfolio, to reduce downside risk.
The second reason that I want have some bonds in my portfolio is because Benjamin Graham says so (at least 25% bonds). Benjamin Graham knows what he is talking about. He was around for a long time, during the depression, post-depression and all the way until the 1970s. He has seen many ups and downs. In the Intelligent Investor (1973 edition) he says that:
even high-quality stocks cannot be a better purchase than bonds under all conditions–i.e., regardless of how high the stock market may be and how low the current dividend return compared with the rates available on bonds. A statement of this kind would be as absurd as was the contrary one–too often heard years ago–that any bond is safer than any stock. [emphasis his]
At the end of the chapter, after much discussion (you will have to read it), he concludes that
Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket–neither in the bond basket, despite the unprecedentedly high returns that bonds have recently offered; nor in the stock basket, despite the prospect of continuing inflation
In Chapter 4 he addresses bond-stock allocation in more detail for the defensive investor. It can be summarized as the following:
He should divide his funds between high-grade bonds and high-grade common stocks. We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.
Note that Graham does not discriminate by age. Jason Zweig goes on in his end-of-chapter why going 100% stocks may be ok for a small minority of the population:
For a tiny minority of investors, a 100%-stock portfolio may make some sense. You are one of them if you:
- have set aside enough cash to support your family for at least 1 year
- will be investing steadily for at least 20 years to come
- survived the bear market that began in 2000
- did not sell stocks during the bear market that began in 2000
- bought more stocks during the bear market that began in 2000
- have read Chapter 8 (The Investor & Market Fluctuations) in this book (The Intelligent Investor) and implemented a formal plan to control your own investing behavior
Personally I do not think I fit into this small minority. Secondly I think that going with a 100% portfolio goes against my third and final reason for wanting some bonds in my portfolio: rebalancing. If you have a 100% stock portfolio and the market tanks by 20% this year you cannot take advantage of rebalancing. If you have a 75% equities, 25% fixed-income/bond portfolio and the stock market tanks by 20% this year, your allocation will shift to 71% stock, 29% fixed-income/bonds. Assuming you can do this in a low-cost fashion, you can instantly get a hold of cheap stocks by selling part of your bond portfolio and buying equities.
Getting back to the whole age thing, I do not think it really matters. When you get really old you should obviously be more focused on income and capital preservation than when you are young. But I do not think people in their 20s should invest any differently than people in their 30s and 40s. That is, I think they should have some bonds in their portfolio no matter what. Capital preservation should be just as important to someone in their 20s. And as Loi mentioned in his article, the average return of a 100% stock portfolio from 1960-2004 was 10.5% whereas the average return for a 80% stock/20% bonds portfolio was 10.1%. I haven’t verified those figures but I have seen similar graphs and numbers quoted before so I am not surprised. I cannot think of why anyone would not want to take a small 0.4% hit on their return for the lower risk offered by a mixed bonds/stocks portfolio.
Initially my advisor did one of those risk surveys on me and I fell into the 100% equity category. Unfortunately those risk surveys are seriously flawed. Just because you have held stocks and mutual funds in the past, have a 30+ years time horizon, have a sound knowledge of investing, and can answer a bunch of other basic questions does not mean that you should automatically be in a 100% equity portfolio. I insisted that I have 25% fixed income (à la Graham) so my new portfolio at Clearsight will hold 25% TD Canadian Bond fund for now (great for rebalancing with as their are no commissions as with ETFs).