There is a lively discussion on the My Financial Journey blog about whether a young person should invest 100% in stocks if he/she doesn’t care about short term volatility. I’m writing my comments here because it’s kind of long.
My Financial Journey said:
For some reason I can’t get it through my thick skull why someone would put any money in a historically lower performing investment tool for money that won’t be touched for 30 or more years.
That’s a very good question. Coincidentally blogger makingourway has a post on this subject which I agree with. He said:
I recommend investors think of bonds as a form of stored investment capability – like a battery. When the market goes down, you have your bonds – often stable in value – as a source of capital to buy into a cheap market.
Bravo! When the stock market goes down, people start losing their jobs or not getting raises. You have less or no money to invest precisely when it’s the best time to invest. Having a battery is nice so you can discharge from it and rebalance into stocks when they are down.
By the same token, when the stock market does well, people get better paying jobs or receive more bonuses and have more money to invest, but you are investing at a high price if you are 100% in stocks. Having a 80% stocks 20% bonds or 60% stocks 40% bonds portfolio makes you recharge your battery when the stock market is high. Being able to buy low and sell high is crucial to long term investment success.
Another point is that even over a long term, you can’t be sure that stocks will return higher than bonds. There are not that many non-overlapping 40-year period in stock market history. You usually see stock market data since 1926. That’s only 2 non-overlapping 40-year periods until now. Non-overlapping is important because saying stocks beat bonds from 1926 to 1965 AND from 1927 to 1966 doesn’t really prove anything. The two 40-year periods have 39 years in common.
Like in football, if team A beat team B in two 40-year-long games that were ever played (1926-1965 and 1966-2005), are you sure what will happen in the 3rd game? You know the players, refs, and perhaps the rules, were different in the two games in the past and they are also different in the 3rd game now. Do you really want to put all your investments on the line for your bet? I wouldn’t.
Stocks are more likely to return higher. So I put 60% of my money in stocks. If you feel stronger on your bet, you can put more, 70%, 80%. But I wouldn’t be “all in.” A person has only one 30- or 40-year investment horizon. If your 40-year period turns out to be bad, it doesn’t matter how the other periods in the past did. Real life is not statistics or a math game.
That is why most investment books recommend 15-20% bonds even in the most aggressive portfolio.