DR 049: How Much of Your Retirement Nest Egg Should You Invest in Stocks?

In the 31-Day Money Challenge, we covered the basics of asset allocation. Today we are going to focus more specifically on how much to invest in stocks and how much in bonds. The stock/bond allocation is the most important piece of asset allocation.

The question of stocks vs. bonds is much more important than the question of US stocks vs. foreign stocks or whether you focus more on emerging markets, REITs, or small caps. Over the long term, your portfolio’s overall return will be driven by how much you invest in stocks.

There’s no one perfect way to divide your assets between stocks and bonds. It’s not like you can dump a bunch of information into a calculator and have it spit out the perfect allocation. Instead, my goal here is to give you a good base of knowledge, tools, and resources that you can use to make an informed decision as to what’s best for you and your family.

With that being said, I do think that there are some wrong ways to allocate assets between stocks and bonds. Either extreme on the stocks vs. bonds spectrum is likely to be problematic. But, even there, the key is that you understand for yourself the pros and cons of any division you make.

So with that, here are my four best pieces of advice:

1. Don’t get hung up on the small things

Readers send in a lot of emails asking about making small changes in the stocks vs. bonds balance: “What if I put 75% in stocks, when I should have put in 70% or 80%?”

People are really nervous about this, and they start getting hung up on a couple of percent here or there. This is putting too fine a point on it. Yes, it’s an important decision, but don’t get hung up on the smaller increments.

The bigger question is more like: “Should I put 75% in stocks or 50% in stocks?”

Asset allocation is not an exact science. So try to look at overarching divisions, rather than super-fine distinctions between stocks and bonds in your portfolio. Sure, every change is going to make some difference, but in the long term a few percent isn’t going to make that big of an impact.

2. You’re balancing three competing issues

The question of stocks vs. bonds is complicated in part because you’re balancing three competing issues: risk of loss, risk of not having enough, and yourself.

Risk of Loss: This is the issue I think gets the most attention because it’s the one that everyone is most afraid of. We’re scared of the stock market because we see it go down 10%, 20%, or even 40% in a year, and that gets a lot of attention. Most of us appreciate that in the long run, stocks will do better than bonds – but we’re still scared of them.

To put this in perspective, let’s look at a resource from Vanguard. This PDF resource includes a chart that shows you everything you need to know about the potential risks and rewards of stocks. It looks at 87 years’ worth of market history for stocks and bonds.

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Topics: Asset AllocationInvestingPodcastRetirement Planning

3 Responses to “DR 049: How Much of Your Retirement Nest Egg Should You Invest in Stocks?”

  1. Higher risk equals higher reward! Just make sure you can stomach the downturns and move more and more into bonds as you get closer to retirement. I think every asset allocation should have at least 20% bonds, ramping up to 70% – 80% as you hit retirement.

  2. What I would do is to start with high stock/bond ratio to start with. As I come close to retirement I would start getting out of stocks and putting my money into more solid investments. I actually like rental property which gives me rental income and property value appreciation. The key is to buy properties that are on high demand, near the public transport links and in central locations.

    I think you need to know if you can handle the fluctuations in the stock market mentally. If you are losing too much sleep over slight drops in the market, probably stock investment isn’t for you.

  3. Ralph Parekr

    I think the chart provided showing the 0 – 100 % Stock allocations could be expanded for 100% bonds and 100% stocks and show how the values varies in years. For instance, if equal amounts of money were invested in both bonds and stocks, at some point in time the expected low value of the stock is equal to the expected low value of the bond. At this point, say X years, the minimum value or loss risk is equivalent. One could set aside all monies that would be needed within X years an invest in bonds this would include all emergency funds, other reserves plus know living expenses for retirees. All monies needed after X years would be invested in stocks. X years could be adjusted to sooner to meet your risk tolerance if you are somewhat risk adverse. Of course it does not make sense to move the bar out further. Motley Fool suggest that monies needed in less than 5 years should not be invested in stocks. This would be for someone with some significant risk adversity in my opinion and it is probably 10 years (or more) for someone hypersensitive to risk. This becomes a basis for a simple two bucket system. Stocks could be easily invested in VTI (Vanguard Total Market) and VB Vanguard Small Cap) at 60%/40% which becomes a truer total market fund. Also more shares could be invested in an international fund.

    I don’t think Warren Buffet actually has to depend on his money for immediate expenses so he may be somewhat prejudiced. He is well beyond the ‘power curve’.

    My problem with bonds is that for shorter term investment, the return is uncharacteristically low almost to the point that it is not worth the risk over the best CD you can get for the same term. Bond funds is this extremely low interest rate environment can be anticipated to loose value if interest rates climb for the next decade. I’ve decided to use preferred stock funds as an analogy to bonds which offer a 5-6% return But it will have value problems when interest rates starts to take off.

    If you don’t need your money for at least X years, it should could be invested totally in stock, but well (enough) diversified. Annually or more often, the assets should be reallocated to meet your risk tolerance. Note that I don’t really prescribe to a fix percentage allocation. But I’m open minded on the subject. It is just that where is the data.

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