This should be the mix of fixed income and equities in a long-term portfolio

Habitually the portfolio or portfolio of investors usually has a percentage of fixed income and variable incomeasset allocation or “asset allocation” involves deciding the percentage of the portfolio or portfolio that we will use in each type of asset, not only in the specific assets to be considered.

Deciding in practice what percentage will be applied often depends on non-objective factors. There are people who choose to have everything in fixed income, because their aversion to risk ends up pushing them. On the other hand, there are people who mistakenly believe that bonds do not provide profitability, so they occupy their entire portfolio with shares. These investors may be wrong.

A study in 2004 published in the US compared the profitability of bonds with shares between 1960 and 1996, reaching the conclusion that discounting inflation, shares gave a 5.5% per annum and bonds 3%, with much less risk. However, we must bear in mind that in the world after the real estate crisis of 2008, bond yields have decreased a lot.

Aversion or propensity for risk, the usual but incorrect way of choosing asset allocation

In general, what has been done is to ask the buyer of the financial product for his tolerance to risk in the following way: are you willing to lose profitability (earn less money) in exchange for security? This is a serious error since:

  • Trigger loss aversion bias in the investor of the financial product, with which the decision is not completely rational or based on the mathematical expectation of the investment.
  • It ignores the investor’s circumstances, Barring your propensity for risk, what is your age? What disaster does a loss of 10, 20 or 30% of his investment mean for the investor? Will he be able to recover?
  • It ignores the portfolio circumstances, the more diversified it is in variable income assets, the lower its risk will be. Maximum diversification is usually achieved by investing in index products. In fact, if the entire portfolio is invested in a single type of bond, we would be running a much higher risk than a portfolio that is highly diversified in shares worldwide. Although the bond is a low risk asset and the shares a higher risk asset.

Then how can we adjust the asset allocation in stocks/bonds?

The ideal is to adjust to the age

The father of “value investing”, author of the book “The Intelligent Investor” and mentor of the successful investor Warren Buffet recommended that In the last years of life, investors will choose to move their portfolio to fixed income, that is, bonds and the like. Go increasing our money in bonuses also recommend it American finance guru Jane Briant Quin.

Why should we increase our participation in fixed income as we age? Mainly because as we get older we will have less time to live to recover the losses that we may have experienced by investing in more volatile and profitable assets, compared to having done so in more stable assets. According to some authors such as Charles Ellis (Winning the Looser’s Game) it took at most 20 years to recover our position adjusted for inflation between 1900 and 2000.

The question is what percentage should we invest in bonds? Well it depends on the author. There are those who defend a 50:50 portfolio, which invests half in bonds and half in stocks, but that leaves us with a bad feeling compared to what was mentioned in the previous section. There are also those who think that the percentage in bonds can be our age, so that at 35 we should have 35% in bonds and 65% in shares and at 80 80% in bonds and the remaining 20% ​​in shares . there are those who think that this does not make sense due to the greater life expectancy.

A more conservative way would be the rule of our age +15, that should be our percentage in bonds and the rest in stocks. So at 35 we would have 50% of our savings in bonds and at 70 85%, with only 15% in stocks. From 85 all in fixed income. It is difficult that according to the 20-year rule that we mentioned before we can recover the investment at 105, but it is true that the shares should be worth something if we had to sell them.

On the other hand, it is true that investing in bonds in times of historically low interest rates as we are experiencing now can be frustrating as we may see that party simply lose money. Perhaps that makes us more inclined to put shares in our portfolio, but investment is usually more about managing our emotions than managing the market. Another thing would be if we were willing to assume more risk than these rules indicate, with the idea of ​​rebalancing it towards bonds in the future.

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