Does your stock/bond split really matter?
Over in our Rule Your Retirement service, we've made 2009 the Year of Fiscal Fitness, tackling some aspect of personal fiances each month. In the upcoming issue, we tackle asset allocation. In preparation, I used my Morningstar Principia software to calculate the returns of various mixes of stocks (as represented by the Vanguard 500 Fund) and bonds (as represented by the Fidelity Intermediate Bond Fund) for the past 30 years (March 31, 1979, to March 31, 2009; all portfolios were annually rebalanced).
Before you look at the results. take a guess at the difference in average annual returns between a portfolio that was 70% stocks/30% bonds and a portfolio that was 30% stocks/70% bonds. Go ahead, guess. I'll wait.
[Pause... Tap... Scratch...]
OK, here are the results for various portfolios:
100% stocks/0% bonds: 10.1%
80% stocks/20% bonds: 9.9%
70% stocks/30% bonds: 9.8%
60% stocks/40% bonds: 9.6%
50% stocks/50% bonds: 9.4%
40% stocks/60% bonds: 9.2%
30% Stocks/70% bonds: 8.9%
20% stocks/80% bonds: 8.6%
0% stocks/100% bonds: 7.9%
Did you guess that there would be less than a percentage-point difference between the 70/30 portfolio and the 30/70 portfolio? Many folks might find it surprising.
As with any historical lookback, this one is sensitive to the time period examined. It ends with the worst bear market in decades (though it includes much of the recent rally). Had we ended our analysis on March 31, 2000 (right before the dot-com bubble burst) the 70/30 mix would have earned 15.1% annually, compared to 12.0% for the 30/70 mix. Of course, the 30/70 mix has made more money since then.
Our 30-year period also includes a long-term bull market in bonds, covering a period that saw interest rates gradually decline from all-time highs (the late '70s and early '80s) to all-time lows (today). As rates decline, the value of bonds go up. Given that rates have nowhere to go but up from here, I wouldn't expect 8% a year from the typical bond fund anytime in the near future.
But even given those caveats, I don't think it's worth sweating your stock/bond allocation down to the exact percentage point. From year to year, you'll see big differences among these portfolios. But over the long run, there may not be that much of a difference between, say, a 70/30 portfolio and a 50/50 mix.
Now, when you look at extremes -- such as an all-stock portfolio or an all-bond portfolio -- you see a bigger difference, which can result in huge disparity in how much money you'd actually have over the long term. The Vanguard 500 earned "just" 2.2% a year more than the Fidelity Intermediate Bond Fund, but $100,000 invested in the former 30 years ago turned into $1,780,056, compared to $974,846 invested in the latter. A two-percentage point difference, compounded over decades, is powerful stuff.
The bottom line: Choosing to include stocks or bonds in your portfolio will have a large impact on your future wealth, but -- with a long-term portfolio in an uncertain world -- there's likely no need to spend too much time deliberating over a 10-percentage point (or perhaps even 20 percentage-point) difference in the allocation that you choose.