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Deciding the Trade-Off Between Volatility and Return
By JLP | April 12, 2007
In yesterday’s Question of the Day post, I stated that I didn’t like lifecycle funds because most have a 15% allocation to bonds, no matter what your age. A reader named Duane left the following comment regarding that statement:
I seem to recall reading that a 90/10 balance between stocks and bonds has on average the same rate of return with less volatility. By that measure, a lifecycle fund with a minimum of 15% in bonds may not be a bad thing.
That statement got me to thinking…
So I fired up Excel and went to work comparing a 100% large cap stock portfolio with a 90/10 portfolio using the numbers found in Ibbotson’s Stocks, Bonds, Bills, & Inflation
Over the entire 81 year period (1926 - 2006), a 100% large cap stock portfolio outperformed the 90/10 portfolio 61% of the time. From 1926 - 2006, the compound annual growth rate for 100% stock portfolio was 10.42% compared to 10.10% for the 90/10 portfolio. It seems pretty close. However, that .32% difference can really add up over the years.
Because all I had to go by were yearly numbers, it was hard to judge volatility. So it is hard to judge the tradeoff between the increased return of the 100% stock portfolio and its increased volatility. My thought: if you’re investing for the long-term, who cares about volatility? Naturally, as you age, you should move your money into some bonds for stability purposes. However, it’s important to keep in mind that retirement itself can be 20-30 (or more) years, which makes you a long-term investor.
10 and 20-Year Rolling Period Comparisons
Over the 72 10-year rolling periods, the 100% stock portfolio outperformed the 90/10 portfolio over 72% of the time. The chart below was put together using the growth of a $10,000 investment over each 10-year rolling period.
.GIF)
And over the 62 20-year rolling periods, the 100% stock portfolio outperformed the 90/10 portfolio 57 times (nearly 92% of the time). And, all 5 times that the 100% stock porfolio was outperformed by the 90/10 portfolio occured in the first 5 20-year rolling periods. Again, the chart below illustrates the growth of $10,000 over each 20-year rolling period.
.GIF)
I’m certain that the 90/10 portfolio would offer some decreased volatility. However, one has to decide how important that decreased volatility is to them.
Topics: Investing |
