Maybe you should be putting all your eggs in one basket after all.
In investing circles, the all-stock portfolio is having a moment. The idea is that putting one’s entire retirement account in a diversified basket of stocks is likely to generate higher returns while also doing a better job of preserving capital.
This is sacrilege to the financial establishment. Splitting one’s assets between stocks and bonds is a foundational concept in investing for retirement. It informs everything from the 60-40 portfolio, to target-date funds, to robo-advisers’ automated portfolios.
Bonds are meant to act as a stabilizer, lowering the overall level of risk in a portfolio and mitigating losses when the stock market is tanking. As an investor ages and gets closer to retirement, traditional financial advice suggests that the bond component should steadily rise in order to limit exposure to the whims of the stock market.
So how have bonds been performing in this crucial role? Not great, according to a growing body of research.
Over the long term, bonds are much riskier than previously thought, said Benjamin Felix, portfolio manager and head of research at PWL Capital. He cited a research paper from last October that examines asset class returns dating back to 1890 for 38 developed countries.
After running the data through a million simulations, the ideal portfolio emerged: all equities, split between the domestic market (35 per cent) and international stocks (65 per cent). Zero bonds. In fact, any bond allocation, however minimal, resulted as a drag on performance.
“Bonds add virtually no value for the lifecycle investors we consider,” the authors said.
There’s more. Investors rely on bonds to generally work in the opposite direction of stocks. But over long-time periods, the movements of domestic stocks and bonds start to become aligned.
“It’s not a given that stocks and bonds are negatively correlated,” Mr. Felix said. “That should have never been something that investors took for granted.”
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The attitude of the average investor toward bonds today has been heavily influenced by a bull market that lasted the better part of four decades.
Between 1982 and 2021, falling interest rates were a financial megatrend that steadily pushed bond prices upward. Bonds did a pretty good job of countering stock market fluctuations over this period as well.
But 2022 brought on a brutal reversal. Inflation upended the global financial regime, interest rates spiked, and one of the worst bond market crashes in history took hold.
The fact that bonds and stocks plunged in tandem made for a deeply uncomfortable year for investors, many of whom started to question their own bond allocations.
“That was a wake-up call for a lot of investors that held incorrect beliefs about the relationship between those two asset classes,” Mr. Felix said.
But it wasn’t the first time that the idea of an all-equities portfolio gained traction. In 1994, professors Richard Thaler – who has since won a Nobel Prize – and J. Peter Williamson presented evidence that investing everything in stocks was the superior approach to the standard 60/40 stock/bond split.
The concept was not warmly received by the financial community. What investor could stomach the unmitigated loss of a stock market crash? It’s a legitimate question that applies to investors today.
The average investor isn’t great at sticking with volatile assets like stocks. They panic and sell in a declining market, they get greedy and buy at peaks. This results in a gap between the returns the stock market generates and the returns investors realize. A few years ago, Morningstar pegged the difference at 1.4 per cent a year – equating to $20,000 in lost gains on a $100,000 investment over a 10-year period.
Here is the reason few investors are well-suited for an all-stock portfolio – most cannot stand to watch their money evaporate when the stock market plummets by 30 or 40 per cent.
“Big market drawdowns don’t happen in a vacuum, they happen when the world feels like it’s ending,” Mr. Felix said. “Until you live through that you don’t really know how you’re going to respond.”