Stock/Bond Asset Allocation is Not as Important as You Think

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Looking back at my investing lifetime I am grateful that I started investing in my company 401k immediately upon taking my first full-time position, however, I cringe when I look at how conservative my asset allocations were.

In the beginning, I made a whole host of mistakes like chasing returns blindly unaware of the expenses, or a long-term buy and hold strategy. When I started investing around 2002 I was too heavily invested in bonds because they were far outperforming equities, which were in double-digit negative returns at the time. Fast forward to today, I am now concerned about how many years those actions could have added to our pursuit of Financial Independence.

Rule of 100
During the early part of my investing lifetime discussed above, I used generic principles like the “rule of 100” to guide my stock/bond allocation. This rule of thumb states individuals should hold a percentage of stocks equal to 100 minus their age. So, for a typical 60-year-old, 40% of the portfolio should be equities. This rule of thumb can be adjusted by 105, 110, etc. minus the age as well to increase stock exposure. Today I would argue that this rule of thumb generally is not aggressive enough for someone pursuing Financial Independence on an abbreviated timeline.

Allocation Comparisons
To determine my present asset allocation I compared the 100/0, 90/10, 80/20, and 75/25 stock/bond allocations using the free Backtest Portfolio tool by Portfolio Visualiser. The analysis results are presented below over the 10-year period from 2007 to 2017 using VTSAX (Vanguard Total Stock Market Index Fund) for equities and VBTLX (Vanguard Total Bond Market Index Fund) for bonds. I chose this 10-year period to capture the effects of the Great Recession. Additionally, I ran a similar analysis over the 20-year period from 2001 to 2021 to capture a long time horizon in which someone could conceivably accumulate approximately $1M from beginning to end.

_{Note: VBMFX (Vanguard Total Bond Market Index Fund) was used instead of VBTLX for bonds in the 20-year analysis because VBTLX has an inception date that is less than 20 years old. The 75/25 stock/bond allocation was included in this analysis as a benchmark because it was cited to provide a near 100% success rate for a 4% withdrawal rate (with inflation adjustments) according to the Trinity Study.}

Analysis Results
The overall rates of return of the various stock/bond allocations varied only slightly and the difference between the final balance was not great either. For example, the final balance of the 80/20 allocation differed from the 100% stock allocation by 8% in the 10-year analysis period. The greater difference in my opinion between the portfolios was the volatility during the best and worst years. For example, the 80/20 allocation differed from the 100% stock allocation by having a 21% lower return in the best year but was 23% less severe in the worst year.

Takeaways
My takeaway from this analysis is that the overall rates of return and final portfolio balances are similar among the stock/bond allocations investigated, however, how they performed during the extremes was more significant. Over the 20-year analysis period, the difference in the final portfolio balance may have added only one extra year onto the Financial Independence journey. Being 100% in equities does not appear to be as sensitive to wealth accumulation as other factors like having a high savings rate.

Call to Action
Please don’t stop here. Consider the following actions, and please share your thoughts in the comments below.

• Show yourself some compassion when looking back at your investing lifetime concerning the stock/bond allocation because investing regularly over time is more important than optimizing returns.

Links

• Backtest Portfolio tool by Portfolio Visualiser.
• Trinity Study – Sustainable Withdrawal Rates From Your Retirement Portfolio by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz