Originally posted by: Special K
If I have 40 years until my projected retirement, is there any point in holding bonds? Wouldn't I end up with higher returns by keeping 100% stocks for most of my working life? Based on what I have read, it seems like the only reason for young investors to hold any bonds is for the psychological value - i.e., they help you sleep at night knowing that your losses will be limited during a bear market, and the overall volatility of your portfolio will be lower.
If I feel I can stomach the risk and ride out the down periods (and with a 40-year investment horizon, why couldn't I), then is there any reason for me to hold bonds?
I'll bet many young investors believed they had the stomach for 100% stocks, but then panicked and sold as soon as they hit their first bear market.
Over the last 200 years, stocks have returned about 10% and long term T-bonds have returned about 6.5%. Of course, due to inflation, subtract just over 3% from each. So, yes, mathematically having all stocks is the way to go. Like I said, all stocks will be a slightly better return. But for most people, the slight additional return just isn't worth the massive additional volitility.
Simply put: if only 10% of your money is in bonds, having that small bit do a little worse won't really have a major impact on you.
As a quick example, I ran some numbers. Suppose you put in $500 a month now in a tax deferred account and each month you increase it by 3% to match 3% inflation rate. Suppose stocks got a 10% return (7% after inflation) and bonds got a 6.5% return (3.5% after inflation). Suppose you kept your money at 90% stocks and 10% bonds each month. Suppose there is no dollar cost averaging effects and no rebalancing effects. Suppose you do that for 40 years and that tax rates don't change. What happens?
Case 1: 100% stocks, you can withdraw about $2983/month after tax (in today's dollars) when you retire.
Case 2: 90% stocks, 10% bonds. You can withdraw about $2705/month after tax.
So, yes, there is a difference. But the difference isn't dramatic.
Now, lets suppose you get dollar cost averaging of bonds and rebalancing from stocks to bonds bonusses. That $2705 will increase due to these effects. The difference is even less than what I mentioned above. Considerably less depending on complex timing issues that are too much effort for me to put into this thread. You are probably looking at $2800 to $2900 a month in the 10% bond case.
The benefit of going all stocks now is there, but it is small. An extra $200 a month when you retire won't really change your life at all.
You mentioned the risk. If the young people panick and get out of the market or do something stupid, they can retire with next to nothing. For most people, I'd say, take that small hit that they'll never notice and avoid that risk.
If you are certain about your ability to handle the risk, then go all stocks. Historically that is the best mathematical move. Note: historic averages don't ever apply exactly to current markets. If we know for sure that the stock market will fall, then mathematically it is best to be heavy in bonds for the short time and then switch to all stocks later. But timing that is nearly impossible.
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