I agree that a person shouldn't have more invested in stocks than he/she can tolerate, but there are purposes to investing in bonds and other assets aside from reducing volatility. Otherwise everyone should just invest as much as possible in an asset like managed futures or emerging markets small cap value stocks depending on if you're going for momentum or value.
How Much of Your Nest Egg to Put Into Stocks? All of It
By DAVID A. LEVINE
FEB. 12, 2016
Let's say you were persuaded by my argument in last week's Retiring column — contrary to the advice offered by most financial experts — that you should not reduce your exposure to the stock market as you grow older. Or you're at least willing to listen to this contrarian advice.
But now what? Whatever your age, how much of your investments should be in equities? Should it be 30 percent? 60 percent? 90 percent?
No less an authority than Warren E. Buffett has stated that 90 percent is the right answer. That's a level of investment in stocks that many investors, not just older ones, find dangerously uncomfortable, particularly when the stock market is as volatile as it has been lately. Yet Mr. Buffett, the most renowned investor of our time, established a trust for his wife that puts 10 percent of his bequest in short-term government bonds with the remainder invested in a broad-based stock index fund.
But even Mr. Buffett's advice may be too conservative. Indeed — except for known, near-term financial obligations like a large tax bill that you might owe on April 15 or a down payment on a house you're buying in the next few months — the best asset allocation, nearly all the time, is 100 percent stocks.
You may wonder if I put my money where my mouth is. I do. As long ago as the late 1970s, I was investing 95 percent to 100 percent of my liquid assets in common stocks. This didn't change even when I ran the bond department at my old firm during the 1980s. And it remains true today.
If one of my clients happened to ask me what I thought their proper asset allocation should be, I would tell them that, despite my job, I was almost 100 percent invested in stocks myself. I even suggested that they take away the money we were managing and turn it over to our firm's equity money managers.
Many investors simply cannot stomach the volatility that a 100 percent equity portfolio entails. Perhaps that is why Mr. Buffett tempers his advice and suggests "only" 90 percent stocks. (In his heart of hearts, I suspect, Mr. Buffett is probably a 100 percent kinda guy.)
And, so, what I actually say to people who ask my advice is this: Put as much money into the stock market as you can stand. One hundred percent is best, but even if you are very risk-averse, allocate at least 75 percent to stocks.
There are reams of data showing the superior performance of the stock market over many generations. In the last 90 years, according to Morningstar, stocks have outperformed long-term Treasury bonds, on average, by 4.4 percentage points a year. They have done even better against intermediate- and short-term Treasuries, 4.8 and 6.6 percentage points.
That kind of performance edge (compounded) really adds up. Let's say you invest some money in stocks halfway through your working career (say, at age 45) and spend those particular savings halfway through your retirement (say, at age 75). If your investment does 4.4 percentage points better per year than the next person's, you will have more than three and one half times as much money to spend as they will.
Looking at rolling 30-year periods, stocks have always outperformed Treasury bills and intermediates and have only rarely underperformed long-term Treasuries. Even for periods as short as five years, stocks have done better than the various fixed-income categories 71 to 76 percent of the time.
Of course, "past performance," as we are constantly reminded, "is not necessarily indicative of future results." And that's true: For a variety of reasons, I believe you should not expect a broad portfolio of stocks to outperform bonds by as much in the future as they have in the past.
Historical experience certainly doesn't resolve all the questions. The great economist Paul Samuelson wrote: "We have only one history of modern capitalism. Inferences based on a sample of one must never be accorded sure-thing interpretations."
He was exaggerating to make his point — countering those who would claim they have a large and statistically unassailable sample size simply because they have 90 years of consistently superior stock market performance. All that data, after all, covers only 15 business cycles, merely three generations and as Professor Samuelson said, just "one history of modern capitalism."
So, is there some other justification besides the reams of data? Are there sound reasons to believe that it is necessarily true that stocks will win over the next generation and the one after that? Yes.
My argument for full equity exposure rests not only on their historical and empirical superiority but their logical superiority. Consider this:
■ Money invested in a United States total stock index fund will be used to buy shares of thousands of companies in dozens of industries. At this writing, every $2 million represents an ownership interest of approximately one ten-millionth of almost the entire United States economy.
■ Economic potential never drops because knowledge — the main source of per capita growth — always rises. Technology (knowledge embedded in machines) gets better because we invest in research and development and never (at least intentionally) replace a good machine with an inferior one. Moreover, the capability of the average worker (knowledge embedded in our brains) keeps rising because average educational and training levels continue to rise.
■ As a consequence, the intrinsic value of your equity investments rises over time. This isn't true for every single company, but it is surely true for all companies taken collectively.
The economy, of course, does not grow every quarter or year. Just six and a half years ago, we emerged from the 11th recession since World War II. But the potential of the economy always grows, which is why after virtually every recession, the economy attains heights never reached before.
To be sure, the path of equity market valuation is far more erratic than the economy — stocks often require a number of stock market cycles to attain new inflation-adjusted highs — but the long-term trend is inevitably rising.
Inevitable? O.K., perhaps I'm exaggerating a bit. None of this has to happen. Theoretically, we could (collectively) choose to substitute inferior technologies for superior ones. Inferior technologies sometimes "win" because of superior marketing (think V.H.S. vs. Betamax), but that is the rare exception, not the rule.
It is also plausible, given that American educational levels are so high, that they could stop improving, or even slip. But that is not really conceivable on a worldwide basis — at least for many generations — since the developing world is so far behind.
But what if the absolute worst happened? A pandemic of epic proportions, a nuclear holocaust or the Earth is hit by an asteroid?
Yes, your stocks will collapse but your bonds will be worthless, too. If there is no functioning modern economy, the government will not be able to pay its debts. And if you're still around, you'll have bigger things to worry about.
The upshot is this: Both the historical record and logic argue very strongly for stocks over bonds. Yes, stocks are more volatile, but if you recognize that the "investment horizon" is always long and always receding into the future, your best bet is to put virtually all of your liquid assets into the stock market.
David A. Levine is a former chief economist at Sanford C. Bernstein & Co., now a unit of AllianceBernstein, who also founded and ran the firm's fixed-income department.
Posted by: Allen Green <gtwhitegold@gmail.com>
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