The most dangerous guide to your financial management is “conventional wisdom.” Conventional wisdom is what everyone believes to be true. In fact, this wisdom is believed so completely, it is never challenged. However, when closely inspected, this wisdom is often found to be false. Here are some examples:
In this article, I will take a closer look at the first issue above---how some retirees, thinking that bonds will make their portfolio more conservative, are making their portfolios more risky. This is a summary of an article that appeared in the AAII Journal, February 1998.
Every retiree is faced with the question of how much to keep in the stock market vs. how much to keep in bonds. Many believe that keeping more money in bonds produces a safer portfolio and greater financial security. Based on the study by AAII, this conclusion is incorrect.
Let’s take an example of a retiree who uses their portfolio ($500,000) as their income source and withdraws 8% ($40,000) annually of the initial portfolio to live on. Measuring since the end of WWII, if that portfolio were invested 50% in stocks and 50% in high grade corporate bonds, there is a 52% chance that the portfolio would have been exhausted. However, if that portfolio were invested 100% in stocks, there is only a 10% chance that the portfolio would have been exhausted by the withdrawals. Conclusion: in the post war period, stocks have been a far safer alternative for making retiree assets last.
So why do many people think that bonds are safer? Because bonds fluctuate less than stocks. However, the greater fluctuation of stocks in the short run does not make them less safe in the long run. In fact, in the long run, stocks have proved a superior store of value. It’s by focusing on the short run that some investors draw conclusions which are incorrect, and possibly financially devastating to their long term financial health.
What is the appropriate allocation of stocks and bonds for you? That depends on the degree to which you rely on your portfolio and the degree to which you are comfortable with fluctuations in the short run. We can help you determine the appropriate portfolio mix to have your portfolio last with the charts we have available illustrating sustainable rates of return. If you would like to have your portfolio measured against these charts, call to schedule a free review.