Bond to Equity Allocation Percentages

So you’ve decided that you would like to try and gain some volatility versus return free lunch via some Bonds mixed in with your Equities or Equities mixed in with your Bonds.  The next million dollar question to answer is then how much of your wealth should be allocated to each asset class.  This is a critical question as it will likely have a big affect on your long term portfolio return.

Unfortunately, as with many investing questions, I'm yet to find a silver bullet but considerations will certainly include your tolerance to volatility and risk.  Assessing this tolerance is of course easier said than done.  For example if you’re naturally risk averse you might choose to load up with more bonds as history suggests they might dampen volatility at the expense of some return however this adds absolutely no value if you then have a low probability of  ever achieving your long term goal.  Conversely there is then no point loading up with more equities to then sell at the first significant equity downturn.  On top of this there could also be age considerations.  For example every year that passes gives you less time to rebuild wealth before retirement.

So what do others have to say about bond to equity allocation percentages?

The granddaddy of value investing, Benjamin Graham, in his excellent first published in 1949 revised multiple times book, The Intelligent Investor, says “We have already outlined in briefest form the portfolio policy of the defensive investor.  He should divide his funds between high-grade bonds and high-grade common stocks.  We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.  There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.  According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the “bargain price” levels created in a protracted bear market.  Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgement of the investor the market has become dangerously high.”

You won’t have to trawl very far to come across the Age in Bonds or 100 less your Age in Equities rule of thumb.  If you’re 25 years of age it simply says you’re looking to hold 25% in Bonds and 75% in Equities.  John Bogle, who was the founder of Vanguard, in his book Common Sense on Mutual Funds, appears to support the rule of thumb during wealth building and then flips and supports Graham during the greyer retirement drawdown years with the quote "Long before the crash, I had fine-tuned my rule-of-thumb asset allocation model, centred at 50/50 for older investors in the distribution phase of their investment plan. Rather, I recommended -- as a crude starting point -- that an investor's bond position should be equal to his or her age.”

William Bernstein in The Intelligent Asset Allocator states “even the most aggressive investors may wish to hold perhaps 25% bonds, with moderately aggressive investors holding a 50/50 mix of stocks and bonds, and conservative investors in the range of 30% stocks and 70% bonds.”

Tim Hale in Smarter Investing (I know I mention Hale a lot on this blog but I only do this because his thoughts work well for me not because we are related or because I'm on commission) adds two further ideas.  Firstly, what he calls a common-sense lifetime approach.  This has 4 different allocations:

• When you are starting out in the accumulation phase – 20% Bonds, 80% Equity
• When you are down the line in the accumulation phase – 40% Bonds, 60% Equity
• When you are starting out in the distribution phase – 40% Bonds, 60% Equity
• When you are down the line in the distribution phase – 50% Bonds, 50% Equity

Hale’s second example then nicely demonstrates that a crucial decision in deciding allocations is also what you are intending to do with the wealth when you achieve the goal.  The rule of thumb is to “take your investment horizon and multiply by four, this is an approximate percentage of equities you should hold in a portfolio.”  This might be worthwhile if you intend to buy an annuity or if you need cash for any other reason at the end of your accumulation phase but I can’t see it working for somebody like me.

So what do I do?  Of course only time will tell if I have it right for me but in brief I'm a modified version of Bogle combined with Graham with the end game being a very early drawdown retirement.  At its simplest I'm holding my Age-10 in bonds with my equities allocation therefore nominally set at 110-Age.  I then add some Graham by valuing 3 key stock markets and I then move a portion of my equities from/to cash depending on those valuations.  More details are contained within my Investment Strategy.  For the 7 full calendar years I've been at this, 2008 to 2014, this method has returned a compound annual growth rate (CAGR) of 6.4% with a volatility of 11.3%.

This has probably been one of my vaguest posts ever but I think that’s because it’s a very difficult and crucial topic which is also a very personal one.  It’s also one where it is especially crucial to DYOR.  I think Hale does make a good conclusion though – “The only advice I can give is to try your best to see the long-term benefits of your mix, over the period you will be investing for.  Any decision to dampen the bumpiness of your ride should be made in the knowledge that you might well be significantly affecting your lifestyle in the future.”

Given its importance I would love to get the maximum number of views on this topic possible so that we can all learn.  Please do share you Bond to Equity Allocation and why you've chosen it in the Comments below.  Please don’t be shy – each post I make these days gets thousands of hits but only a few Comments.  The more data the more opportunity for DYOR.