Over the long haul, stocks tend to outperform bonds. But for many people, it’s scary to invest in stocks because they are worried about short-term losses. While putting money to work in equities probably makes sense, they either delay investing the money or under allocate equities in their portfolio.
To help people think about this conundrum, Minerva Wealth Advisory searched third-party investment research to find data that could help frame the issue. One of the best research reports we found was published by Vanguard.Buried inside their report was an interesting chart summarizing the impact of broad asset allocation on risk and return. A simplified version of the Vanguard chart is shown below.
In this clever piece of analysis, Vanguard assembled 87 years of data on returns from investing in U.S. stocks and U.S. bonds. They used this data to create portfolios that moved from being entirely invested in U.S. bonds to portfolios entirely invested in U.S. stock, with stops along the way to incrementally increase the portion of the portfolio invested in equities.
As the portion of the portfolio devoted to equities increased, so too did the volatility in annual returns, as evidenced by the longer bars on the right. Volatility is the pain, otherwise known as risk, that comes with the potential to earn higher returns. In the middle of each bar are the average annual returns each portfolio delivered, both nominal returns (which is before accounting for inflation) and real returns (which is the nominal return less the annual rate of inflation). The larger the portfolio allocation to equities, the higher the annual return.
In their report, Vanguard notes:
‘Although the annual returns represent averages over an 87-year period and should not be expected in any given year or time period, they do give an idea of the long-term historical returns and the downside market risk that have been associated with various allocations. Investors should carefully consider [this figure] as they determine how to achieve their investment goals without exceeding their tolerance for risk.'
*‘Vanguard’s Framework for Constructing Diversified Portfolios,’ published in April 2013. To read the report, go to https://advisors.vanguard.com/iwe/pdf/ICRPC.pdf
DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here. This is presented for informational or educational purposes only and does not constitute a recommendation to buy/sell any security investment or other product, nor is this an offer or a solicitation of an offer to buy/sell any security investment or other product. Any opinion or estimate constitutes that of the writer only, and is subject to change without notice. The above may contain information obtained from sources believed to be reliable. No guarantees are made about the accuracy or completeness of information provided. Past performance is no guarantee of future results.