How much should you invest in stocks?
The answer is related primarily to how much uncertainty and fluctuation in your portfolio value you are willing to bear, the level of assets needed to meet your financial goals and the time you have until cash flow is needed. As a conservative initial approximation, hypothetically assume a stock market decline of 50% as a worst-case scenario. In this scenario, the portfolio would be subjected to the full impact of that decline if you were invested 100% in stocks. Now, consider assigning a fixed-income allocation that, when blended with the equity allocation, will result in a hypothetical decline equal to your downside risk tolerance. For example, if your downside risk tolerance was 25% over the next year, your equity exposure might be 50%. Your allocation between stocks, bonds and cash should reflect a balance between your risk tolerance and ultimate financial objectives.
Keep in mind, most retirees live longer than they generally expect. Today, the average 65-year-old will live another 15 to 20 years, nearly a decade longer than the previous generation. Ultimately, the decisions you, and we, reach with respect to the structure of your portfolio will combine several important financial considerations, as well as the need for you to be comfortable through the inevitable volatility of the investment markets.
Why should I own bonds in my portfolio?
Historically the returns generated from bonds have been roughly one-half of the returns from stocks. However, the volatility of bonds investments is typically much less than that of stocks. Since most investors are not comfortable having all of their financial resources invested in stocks due to the higher short-term volatility, the bond holdings can provide good cushion to a portfolio while generating current income. The percentage of a portfolio allocated to fixed-income investments depends on several factors, the most important being the level of interim risk an investor is willing to assume.