| Sarasota Herald-Tribune
One of the greatest barriers to investors building long-term wealth is fear of volatility. This fear causes many investors to shortchange themselves by often underrepresenting stocks in their portfolios.
This happens even though most investors know in the long-term stocks almost always substantially outperform bonds, CDs, or cash. Studies by Wharton professor Jeremy Siegel quantify this. Historically over lengthy periods, stocks inflation-adjusted returns are about 6.8% and bonds about 2.8%. Of course, this says nothing about returns for a given year. However, for context, stock returns are positive in about 70% of calendar years, stocks outperform bonds in about 70% of decades and there are essentially no 15-year periods when stock returns were negative and no 20-year periods.
These results suggest that distinct types of investors must think about volatility and building and protecting their wealth in diverse ways.
A young investor saving for retirement can look at this data and be comfortable in having a portfolio invested all in stocks. She may have 30 years until she needs any of the money, and market volatility should be irrelevant to her.
An investor within five years or so of retirement, at which time she expects to be totally dependent on her portfolio, must protect it from the possibility of a severe market downturn that could last several years. This can be done by lowering the percentage of stocks in the portfolio to perhaps 40% until, say, five years after retirement and then start increasing the stock percentage. Research studies show this type of strategy will both protect her from a lengthy bad market period and provide the growth needed for a long retirement. Putting100% into bonds could have her spending her later retirement in near poverty.
An investor not in either of these categories can have the best of both worlds. She can calculate how much she will need annually from her portfolio after considering other sources of income, for example, wages or pensions. Then she can keep 3-5 years of that amount in bonds and the rest in stocks. This will protect her from volatility and having to sell stocks during a market decline, while allowing for growth should the market behave normally. Recall, that the market recovers from even the most severe market declines in less than five years. …….
