You always want to be careful when making blanket statements around any investing topic, but if one studies the math around stock and bond volatility, an easy way to reduce portfolio volatility is to add fixed-income securities to a portfolio or pool of assets.
Morningstar did the math in their annual classic, “Stocks, Bonds, Bills and Inflation” Handbook. From 1926 through 2012, here are the Summary Statistics (per Morningstar) of annual returns and standard deviations for various stock / bond allocations:
(The first column is the geometric mean, the 2nd column is the arithmetic mean, and the 3rd column is the standard deviation):
- 100% Large-Company stocks: 9.8%, 11.8%, 20.2
- 90% stocks / 10% bonds: 9.6%, 11.2%, 18.2
- 80% stocks / 20% bonds: 9.0%, 10%, 14.5
- 70% stocks / 30% bonds: 9%, 10%, 14.5
- 50% stocks / 50% bonds: 8.3% 8.9%, 11.3%
- 30% stocks / 70% bonds: 7.4%, 7.8%, 9.2
- 10% stocks / 90% bonds: 6.3%, 6.7%, 9.0
- 100% L-T govt Bonds: 5.7%. 6.1%, 6.7%
* Source: Morningstar, SBBI for 2012, published in 2013
A couple of caveats for readers to consider, or what I think might be thoughtful commentary: the long-term government bond is the U.S. 30-Year Treasury, which is a pretty volatile security, and more so today given the generational low coupon, so if Morningstar were to use the U.S. 10-Year Treasury or even ETFs these days, some of these standard deviations might be considerably lower. Also, readers always have to consider “context”. A deep value portfolio in 1999 that consisted of gold mining stocks and other deeply out-of-favor sectors, might have had a considerably lower standard deviation moving through the 2000s than a 60% / 40% balanced portfolio of large-cap growth stocks and longer-term Treasuries.
If Morningstar re-ran the stats, with a S&P 500 / Barclays Aggregate (NYSE:LAG) rather than the 30-year Treasury, I wonder how the standard deviation would change. I’m sure someone has run the calculation.
Another point which readers need to consider is that, given the 32 year old bull market, which you can say started roughly in 1982 (thinking long-term Treasury) versus the 12 years consolidation within the S&P 500 that just ended in 2013, when the S&P 500 broke out above the March, 2000 and October, 2007 highs, you have to wonder how safe the “bond” part of the portfolio remains today.
Blanket statistics such as these often ignore the “reversion to the mean” perspective we wrote about here in late June, 2014.
I’m also puzzled as to why Morningstar didn’t provide stats on the standard 60% / 40% asset allocation, which for years was the recommended allocation amongst plan sponsors and large pension funds.
As even Morningstar concluded, when measuring risk by standard deviation, a 70% equity / 30% bond portfolio has 1/3rd less “risk” (14.5 vs 20.2) than a 100% large-cap equity portfolio, all other things being equal.
Still, judgment and homework are always your best bet when making longer-term decisions around investing.