What Allocation Should Bonds Have Relative to Equities In a Portfolio?

The age-old question relating to stocks and bonds is how to divide capital allocation across the two asset classes.

Traditionally, equities and bonds were looked to as the primary asset classes to look at when considering where to put one’s money, however it is true that alternative asset classes do exist today which offer investors further diversification.

Focusing only on equities and bonds (alternative investments is a conversation for another day), different asset mixes have been proposed over the years to reflect everything from an investor’s risk-taking/risk-aversion profile to long-term mean reversion with respect to interest rates.

Bonds tend to serve two primary purposes in a portfolio: (1) bonds are typically much safer than equities, and outperform the broader stock market in a market downturn, providing a hedge against any shortfalls experienced during bear markets; and (2) bonds are vehicles used to combat slow-growth or no-growth economic output, as they tend to perform better in low-inflation, low-interest rate environments.

What is considered to be a “traditional” or “safe” portfolio makeup has changed over the years. Iconic investing gurus such as Benjamin Graham have proposed a very simple 50-50 split between equities and bonds, with modifications made based on the current economic situation, with a spread of 70-30 being the maximum an investor should consider (one should always have at least 30% of a portfolio in either stocks or bonds, despite how the market outlook may favor one investment over another.

A 70-30 split is one which I would endorse in today’s market, despite the fact that bonds are expected to significantly underperform equities for some time. As I’ve said before, it’s much better to buy flood insurance before water levels rise, and bonds provide that portfolio insurance better than most asset classes out there.

Invest wisely, my friends.