Since investing is ultimately an act of faith in the financial markets, the main way in which we live out that faith is by dividing our money among a few kinds of assets, each of which grow and decline during different seasons of the economic cycle. And in doing this, we look forward to getting the most out of the markets’ periods of growth, while also ensuring that we withstand their seasons of decline.
Now, for most of us, the main types of assets that we have to choose from are stocks, which seek to provide a high total return on our investment, and bonds, which look to provide reasonable, consistent income. And as you’ll see, each of these assets differs in their level of risk. Stocks can be quite unstable, while bonds are less so.
In other words, by owning these two kinds of assets, you get the most out of the growth potential of the stock market, while at the same time keeping your risk of losing money to a manageable level by owning some bonds as well.
And since risk can be thought of as the amount of money you could possibly lose, let’s take a look at both how often investors in the financial markets have lost money in the past, as well as the amount of money they’ve lost. To be more specific, we’ll look at the frequency and severity of loss that investors with various allocations to stocks and bonds have endured over the years.
Now, in order to show you the results that an actual investor would’ve achieved, we’ll use the annual returns from the Vanguard 500 Index Fund Investor Shares (VFINX) to measure the performance of the stock market. This fund seeks to track the performance of the S&P 500 Index, which is a benchmark that measures the performance of the largest companies in the U.S. As such, it’s widely regarded as a standard measure of stock market performance in the U.S.
And for the performance of the bond market, we’ll use the annual returns from the Vanguard Total Bond Market Index Fund Investor Shares (VBMFX). This fund seeks to track the performance of the Bloomberg U.S. Aggregate Float Adjusted Index, which is a benchmark that represents the broad, investment-grade U.S. bond market.
With that said, the table below includes data on the frequency and severity of loss since 1987, the first year in which the bond fund has data on its returns. In addition to this, the data is calculated with the understanding that at the end of each year, after varying stock and bond market returns had altered each initial allocation, the portfolios were rebalanced to their original proportions.
Risk, Return, and Allocation (1987 to 2024)
| Stock/Bond Allocation (%) | # of Years with a Loss | Average 1-Year Loss (%) | 3-Year Loss From 2000-2002 (%) | 1-Year Loss in 2008 (%) | Annual Growth Rate (%) | Growth of $1,000 Over 38 Years |
| 100/0 | 7 | -15.19 | -37.71 | -37.02 | 10.97 | $52,243 |
| 80/20 | 7 | -11.34 | -26.56 | -28.61 | 10.01 | $37,579 |
| 60/40 | 7 | -7.75 | -14.20 | -20.19 | 8.93 | $25,802 |
| 40/60 | 5 | -6.79 | -0.57 | -11.78 | 7.73 | $16,946 |
| 20/80 | 4 | -5.13 | 14.40 | -3.36 | 6.42 | $10,656 |
| 0/100 | 6 | -3.47 | 30.76 | 5.05 | 5.01 | $6,414 |
Now, in looking at the first row of data, during this 38-year period, the stock market provided a negative return for a total of seven years, or about once every five and a half years. And the average loss in these years was a decline of 15 percent.
But as you move down each row, the table shows how the impact of this average decline has been restrained by various holdings of bonds, ranging from 20 percent to 100 percent. For instance, with a traditional balance of 60 percent stocks and 40 percent bonds, while the number of years with a loss would’ve been the same, the decline averaged under 8 percent, or just almost half of what you would’ve experienced with an all-stock portfolio.
And on a related note, perhaps the three-year market decline from 2000 to 2002 can give you a bit of a worst-case scenario. You see, during that period, an all-stock portfolio fell by more than 37 percent. However, bonds actually grew by over 30 percent. And an allocation of 60 percent stocks and 40 percent bonds lost just under 15 percent.
Then, just a few years later, we experienced another challenging year in 2008. In that relatively brief time, a portfolio invested only in stocks fell by 37 percent once again. However, bonds actually grew by 5 percent. And allocation of 60 percent stocks and 40 percent bonds lost just under 21 percent.
In other words, since these two examples were periods of decline in the stock market, the portfolios with the largest allocations to bonds did the best. In fact, a portfolio invested only in bonds did the best out of all of them.
Now, from these brief examples, perhaps you’re thinking that bonds are a better investment than stocks. But if you’re a long-term investor, though, this would’ve been unwise to conclude.
“Why?” you ask.
Because if you look at the same allocations over several decades, rather than for just a few years at a time, the data makes a strong case for a substantial long-term investment in stocks.
You see, over the entire 38-year period, stocks provided an average annual return of over 10 percent, compared to just 5 percent for bonds. And on top of that, returns increased in direct proportion to the portfolio’s allocation to stocks.
For instance, a portfolio with 80 percent of its assets in stocks and 20 percent in bonds grew at an average rate of 10 percent each year. But on the flip side, a portfolio with the opposite proportion of 20 percent stocks and 80 percent bonds returned just over 6 percent.
And in terms of actual dollars, over the entire 38-year period, a $1,000 investment in the stock-heavy portfolio would’ve grown to over $37,000, while the bond-heavy portfolio would’ve accrued just under $11,000.
In other words, bonds are best used as a stabilizing influence on a stock portfolio, not as a replacement for stocks. Remember, your goal as a long-term investor is not to preserve your money in the near term, but to earn meaningful long-term returns that outpace inflation.
So, although stocks may be risky in the short run, as a long-term investor, if you want to enjoy a comfortable retirement, you may find that you can’t afford not to take these risks. And as you’ll see, the risk of owning stocks diminishes as you hold on to them for longer periods of time.
Okay. At this point, you may wonder, “How do I figure out what the right balance between stocks and bonds is for me?”
Well, to answer that question, as a general starting point, you can set your bond allocation so that it’s equal to your age. For instance, if you’re 60 years old, you’d consider the suitability of a portfolio with 40 percent of its assets in stocks and 60 percent in bonds.
And from there, you can take into account your unique situation, including the amount of money you’ve already saved up, your financial goals, your willingness and ability to take on risk, as well as any pension and Social Security payments you expect to receive.
For instance, if you’re a younger investor who’s just beginning to invest for a retirement that’s several decades away, you likely have a relatively small amount of wealth to expose to risk, as well as no urgent need for these assets. For these reasons, then, it wouldn’t be imprudent to allocate all of your funds to stocks, since, if you recall, there have been no 15-year periods in which the stock fund lost money.
On the other hand, let’s say you’re an older investor who has a substantial amount of wealth to protect, as well as less time to recover from a decline in the value of your portfolio. In this case, you may want to increase your bond allocation beyond the proportion that is equal to your age, which is suggested as a general starting point.
Okay. Once you’ve decided on the suitable asset allocation for you, in order to keep your ratio fixed, you’ll need to rebalance your portfolio every now and then. For instance, if strong stock markets alter your original allocation of 60 percent stocks and 40 percent bonds to a mix of 70 percent stocks and 30 percent bonds, you’ll want to sell the appropriate amount of stocks and reinvest the proceeds in bonds.
Now, this is pretty straightforward to do in a tax-advantaged retirement account such as a 401(k) or IRA, where you don’t need to pay taxes on any capital gains in order to make your portfolio adjustments.
But if your investments are mostly in a taxable account, then a sale of assets will likely result in unwanted tax consequences. For that reason, a more cost-effective method would be to invest future contributions in bonds to restore your portfolio to its desired allocation.
On the other hand, if stocks were to decline in value, you’ll want to either sell some bonds or direct new contributions to stocks in order to bring your portfolio back to its original allocation.
So, the bottom line is that despite going through noticeable losses every now and then, the stock market has eventually recovered. And for that reason, a balanced portfolio puts you in the best position to take advantage of these changes. In other words, by owning both stocks and bonds, you increase your chances of growing your wealth over the long term, while ensuring that your portfolio maintains some of the value it has built up when the stock market goes through temporary downturns.