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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76406  
Subject: Re: Bonds Date: 4/19/2004 1:27 AM
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Why 50%?

If you're retired, I think a 50% stock, 10% REIT, 40% bond is the right mix of stability and growth.

The problem with stocks is, from time to time, they decide to drop by 50% or more, and sometimes remain at depressed levels for decades.

The idea that stocks always bounce back to their all time highs after a couple of years is Pollyanaish. Look at the Nikkie or NASDAQ.

The average retiree who will withdrawing 5% of his portfolio per year to pay his living expenses, and will never have new money to invest to catch cheap post-crash stock prices isn't going to sleep very well with an all stock portfolio. Imagine you retired in in mid 2000 with a $1,000,000 portfolio in an S&P 500 fund, and were withdrawing $50,000 per year to meet your living expenses. In mid 2002, you had around $400,000 after withdrawals.

It's also a myth that only bonds will drop as interest rates rise. Stocks and bonds are competing investments, so if the return of one increases, investors will demand a similar increase in returns from the other. Look at stock prices 20 years ago when bonds were paying 18%. I kept seeing the headline "Stocks drop on rate fears" in the news last week. Stocks, not bonds. Will investors tolerate a stock market with a PE of 25 if bonds are yielding a real 10%? Not in a rational world.

I think some people who shun bonds tend to think of them simplistically as treasuries that won't keep up with inflation. And if treasuries were your only choice, I'd lower my bond allocation. But there are many types of bonds, which is why bond funds are so handy. Some bonds are more similar to stocks than treasuries. William Bernstein, for example, expects large cap stocks and corporate bonds to perform equally (5% real return) going forward based on current dividends, interest rates, default rates, and earnings growth rates.

Of course you still want a healthy stock allocation, since they've been historically the best long term investment, which means, at least in theory, you're being compensated for some greater risk (volatility?) beyond the greater default risk of stocks.

The idea that stocks always rise steadily, and always bounce back quickly from crashes is best case scenario thinking. Best case scenarios do happen. Sometimes.

Nick

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