Investment Returns and Asset Allocation

In yesterday’s post, I included a graph showing how stocks and bonds have performed over different time horizons. But of course, you will not invest all of your retirement assets in one asset class or the other. To find the right compromise between the higher return of stocks and the greater stability of bonds, you will want to arrive at the right mix of stocks and bonds—your asset allocation plan. More easily said than done.

The graph below shows quite clearly how mixing the two asset classes has historically resulted in gains and losses that are in between those of stocks and bonds. There are good reasons for mixing asset classes. Most of us want the higher returns offered by stocks, but we could not afford the potential losses if all our investments were in stocks.

And stocks and bonds will behave differently during different economic periods. To some extent poor performance of one asset class will be offset by better performance in the other. This will result in a reduction of volatility, a smoothing of the peaks and valleys of your investment returns. The graph below demonstrates this by showing how a portfolio of 50% stocks and 50% bonds would have performed during different periods in history (the same periods reviewed in yesterday's post), and comparing that mix to 100% stocks and 100% bonds.

Is 50-50 the right asset allocation? No; it’s just an example.