How To Decide How Much To Invest In Stocks Vs. Bonds

Stocks and bonds are two headlining ingredients in a successful investment account. Most investors should have both, but determining the right amounts to invest in stocks vs. bonds can be confusing.

Investing experts will say your asset allocation strategy defines how much you invest in different categories—advice that can also be confusing if you’re new to the lingo. Fortunately, asset allocation is easy to understand and, with the right resources, you can quickly define a stock-to-bond mix that works for you.

What Is Asset Allocation?

Asset allocation is the composition of your portfolio across different types of investments, such as stocks, bonds, real estate and precious metals. It is normally expressed in percentages that add up to 100, such as 50% stocks and 50% bonds. The percentages represent the dollar value of each asset type relative to the dollar value of the whole portfolio.

Being strategic about your asset allocation has several benefits:

1. Diversification. Diversification is the practice of incorporating various investment types in your portfolio to reduce risk and increase returns. A simple and common asset allocation is the 60/40 portfolio, which has 60% stock holdings and 40% bond holdings. A diversified asset allocation discourages over-investing in the same or similar securities.
2. Risk management. Your target asset allocation should reflect your risk tolerance. Generally, stocks provide growth potential and bonds provide stability. If you want more stability, invest in a higher percentage of bonds. If you want more upside—which comes with more volatility—invest in a higher percentage of stocks. For context, the 60/40 portfolio is considered low-to-moderate risk.
3. Formulaic decision-making. A defined asset allocation provides structure for your trading decisions. This is important because rash or emotional decisions commonly lead to below-market returns.

Stock-Vs.-Bond Allocation Strategies

Consulting with a financial advisor is the most thorough way to determine how much you should invest in stocks vs. bonds. An experienced advisor can talk through your investment goals, risk tolerance and timeline to determine an appropriate allocation strategy.

However, if you prefer the DIY approach, you still have options. You can use your age to set your asset allocation with the rule of 110, you can copy a lazy portfolio or you can invest in an asset allocation fund.

Asset Allocation By Age

The rule of 110 is a simple math problem that defines much to invest in stocks vs. bonds. To us the rule, subtract your age from 110. The answer is your age-based stock allocation. If you are 35, the rule of 110 recommends investing 75% of your portfolio’s value in stocks and 25% in bonds. As you age, the rule of 110 advises a gradual decrease in your stock holdings to lower your risk over time.

The advantages of the rule of 110 are:

• It’s simple. The rule is easy to understand.
• It gets more conservative over time. The rule encourages more aggressive investing at younger ages and more conservative investing at older ages. In the more aggressive years, you can build wealth and overlook volatility. In your older years, when volatility is more damaging, the focus is on protecting wealth.

The disadvantages of the rule of 110 are:

• It’s generic. Your strategy may not align with your risk tolerance or investing goals.
• It requires maintenance. The composition of your portfolio will change over time as your stocks appreciate. You will have to rebalance your holdings periodically to restore the targeted allocation. Say you are targeting 75% stocks and 25% bonds. After a year of stock growth, your holdings might be 80% stocks and 20% bonds. Meanwhile, your targeted allocation has changed to 74% and 26%. Rebalancing involves selling off stocks and using the proceeds to buy bonds, to restore the allocation you want.

Lazy Portfolios

Lazy portfolios are defined allocations you can implement with low-cost funds. There are many lazy portfolio, ranging from simple to complex. Here are some examples:

1. 60/40 portfolio. 60% stocks and 40% bonds. This portfolio has low-to-moderate risk.
2. Taylor Larimore’s three-fund portfolio. 64% large-cap blend stocks, 16% international large-cap blend stocks and 20% intermediate-term bonds. International stocks provide broader diversification in this portfolio.
3. Warren Buffett portfolio. 90% U.S. large-cap stocks and 10% short-term Treasury bonds. This is a risky allocation strategy, best suited for younger investors.

The advantages of lazy portfolios are:

• They’re easy to research. Several websites cover lazy portfolios extensively. You can research each portfolio’s historic performance to understand which one might fit your needs.
• They’re easy to implement. Lazy portfolios are designed to be built with exchange-traded funds (ETFs), which are widely accessible through brokerage accounts. You can also implement simple lazy portfolios within most 401(k)s.

Lazy portfolios have similar disadvantages to age-based allocations:

• They have a fixed allocation. Lazy portfolios do not adjust for your changing investment needs as you age.
• They require maintenance. As with an age-based allocation strategy, you should rebalance your lazy portfolio once annually.

Asset Allocation Mutual Funds

Asset allocation funds follow a stated composition strategy, such as 80% stocks and 20% bonds. The fund managers decide which investments will fulfill that strategy, so you don’t have to. Your job is to choose a fund with an allocation, strategy and management team you like—and then invest.

Three popular asset allocation mutual funds are:

1. 85% Allocation Fund (FRAGX). FRAGX has a moderately aggressive strategy, investing 85% of the portfolio in domestic and international stocks. The remaining 15% is in bonds and cash.
2. Fidelity Balanced Fund (FBALX). FBALX is more conservative than FRAGX. Domestic stocks are about 59% of the portfolio. There is a small position in international stocks and the remaining 38% of assets are bonds and cash.
3. American Funds Conservative Growth and Income Portfolio Class F-1 (INPFX). INPFX has 47.5% stocks and 52.5% bonds and cash. The fund prioritizes dividend-paying stocks, which can be less volatile than non-dividend payers.

The advantages of asset allocation funds are:

• They’re easy to research. Mutual fund and ETF websites provide extensive documentation, including performance history.
• They don’t require maintenance. No rebalancing is required since the fund maintains the stated allocation.

The disadvantages of asset allocation portfolios are:

• There’s potential for high fees. Some funds have high expense ratios, which quantify the administrative fees investors must pay. Fees dilute returns.
• There’s potential for high minimum investment. Some funds require investments of $2,500 or more, which can be hard to budget. Fortunately, there are some easy ways to set a target asset allocation, which defines how much you should invest in stocks vs. bonds.

How To Choose How Much To Invest In Stocks Vs. Bonds

Following a strategic asset allocation plan can support higher returns over time, because you are managing risk and minimizing emotional decision-making. Remember that stocks provide growth potential but they can lose value quickly, while bonds deliver income with more stable pricing.

The rule of 110 provides an easy guideline on a stock-t0-bond mix that’s age-appropriate. Alternatively, if you expect your risk tolerance to remain unchanged over time, implement a lazy portfolio or invest in an asset allocation fund. The important thing is to invest in some mix of stocks and bonds, starting now. You can always adjust your allocation slightly as you gain confidence with your investing practice.