The Golden Rule of Asset Allocation: How to Keep 90% of Your Money in the Stock Market and Still Sleep Soundly
In this article, you'll learn:
Recently, #The Economist published an article:
Less than two months into 2024, stock investors are already feeling quite satisfied. The S&P 500 crossed the 5,000 mark for the first time, and Japan’s Nikkei 225 also broke its all-time record. Such a dramatic opening has reignited the age-old debate: Should investors go all-in on the stock market?
Several studies have stirred discussion in the financial world. For a long time, the mainstream advice has been that a stock-bond blended portfolio is the best choice for most investors. However, a new paper from October argues that investors should hold a 100% stock portfolio.
The three scholars who authored the paper claim that an all-stock portfolio (half US stocks, half global stocks) would likely outperform diversified strategies. Their evidence? A dataset going back to 1890.
Some Scholars Advocate Borrowing to Buy Stocks
In real estate, it’s considered normal for investors to borrow money to buy assets. Therefore, some advocate applying a similar approach — borrowing to buy stocks — in the stock market.
Yale professors Ian Ayres and Barry Nalebuff have pointed out that young people benefit the most from the long-term compounding of capital growth, yet they have the least capital to invest. So these two scholars argue that young people should borrow to buy stocks and then deleverage and diversify as they get older.
Cliff Asness, founder of quantitative hedge fund AQR Capital Management, holds the opposite view.
He agrees that a pure stock portfolio has a higher expected return than a stock-bond blended portfolio. But he argues that when you account for the risk investors bear, the actual returns may not be any higher. For investors who can use leverage, Asness still believes it’s better to use an optimally balanced stock-bond portfolio and then borrow to invest more in that balanced portfolio.
He has argued that this balanced stock-bond strategy produces higher returns than a pure stock portfolio. Even for those who can’t easily borrow, considering the risk investors are willing to bear, a 100% stock allocation may not deliver the best returns.
So How Should You Allocate Between Stocks and Bonds?
When deciding whether to set your portfolio’s stock allocation at 60%, 100%, or even 200%, the problem is that financial market history is too short to use as a reliable guide. Most studies finding that stocks outperform other options reference stock performance records going back to the late 19th or even early 20th century.
For a young investor planning for the remainder of their working life, they might be thinking about a half-century horizon. So the current amount of data is still insufficient.
Moreover, when researchers extend the observation period, the picture can look quite different.
A November analysis by Santa Clara University professor Edward McQuarrie examined stock and bond data from the late 18th century to the present. The study found that between 1792 and 1941, stock returns did not always beat bonds.
Using data this ancient to guide today’s investment decisions feels somewhat absurd. Financial markets in those eras were almost certainly vastly different from today. Beyond measurable risks, investors also face unknown uncertainties.
When stocks are soaring, advocates of diversification find life tough, because the cautious approach looks timid. However, the lack of evidence from recent relative returns in financial history — combined with the inability to fully understand what happened in the distant past — means they should hold their ground.
At the very least, advocates of a 100% stock allocation cannot base their argument on what will happen in the long run: it simply isn’t long enough.
Further Reading
The Lazy Conclusion
Long-Term Stock Market Performance — I Believe Having No Cash Is the Real Way to Save
As someone who doesn’t keep much cash, aside from what I need for daily living expenses, almost all my money is in stocks. My stock portfolio is split into short-term, medium-term, and long-term plans. And yes, I’m one of those people who advocates putting most of your money in the stock market. Because it’s a way to hedge against inflation and a way to let money make money for me.
How Can You Put Your Money in the Stock Market and Still Sleep Soundly?
First, you need to deeply understand your own financial situation. Put simply, your finances need to go through proper planning, because financial planning involves calculations that make your #spending scientific, your #consumption rational, and your #earning more practical — there’s no other way.
Think of it like navigation. You always need a destination first. Say you’re planning a trip to Japan, or even just a domestic trip to Hualien and Taitung (花東, the scenic eastern coast of Taiwan). You’ve definitely used GPS navigation before. Hualien-Taitung is your #destination, and #navigation is your plan. Only by planning the route can you avoid getting lost.
Financial Planning Means Taking Stock of Your Assets, Understanding Your Current Situation, and Then Choosing Your Lifestyle
Does Financial Planning Mean You Won’t Lose Money in the Stock Market?
With financial planning, you truly don’t have to fear stock market losses. A well-planned financial strategy won’t leave you unable to live just because you lost money — just like GPS navigation doesn’t guarantee you won’t take a longer route. Or that it won’t lead you down a wrong turn?
Navigation gets you on a road that leads to your destination. Whether the road is long, short, wide, or narrow isn’t really the point. The point is getting you to your destination. I’m sure many of you have been taken down some bizarre little backroads by your GPS before.
Keeping Your Money in the Stock Market Is Safe
Every market has its ups and downs at different times, but is it easy for Taiwan’s TAIEX to drop back to 3,000 points? Not easy! Is it possible for the US market to fall back to 5,000 points? Possible, but the probability is extremely low.
That’s why I always say: #Given enough time, #the stock market will always go up.
Where do you keep your money? Savings accounts? Mutual funds? Bonds? Or insurance? Feel free to leave a comment and share your thoughts on keeping money in the stock market!
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