Asset Allocation (Stocks vs.

Bonds)
How to Understand What it Means to You
 www.folioboost.com

Quantifying Implications of Different Asset Allocations

Everyone knows stocks offer more reward than bonds, but at more risk. The problem is almost
no one has any idea how much more reward and at how much more risk. That is because it is
difficult to quantify.

Based on my long-term assumptions found throughout the website, I attempt it here. The
assumptions are:

Stocks: 8% annualized return with 20% annual standard deviation

Bonds: 4.5% annualized return with 6% annual standard deviation
Correlation between stocks and bonds: -0.1
Inflation = 3%

Using Monte Carlo analysis, we can get an idea of the odds of certain types of results with
different asset allocations and different time horizons.

Using the assumptions above, these tables show the odds of the value of a hypothetical $100
portfolio at the end of different time horizons. They are inflation adjusted at the 3% rate. They
do not account for taxes or fees and assume no withdrawals. If you are taking withdrawals,
these are not an appropriate tool to determine asset allocation.

Current Portfolio Value: $ 100

After
5 Years $50 $75 $100 $125 $150
Stocks/ Less Than to to to to to More Than
Bonds $50 $75 $100 $125 $150 $200 $200
100/0 2% 11% 20% 19% 16% 18% 14%
75/25 1% 4% 23% 24% 20% 19% 9%
50/50 0% 2% 21% 29% 29% 18% 1%
25/75 0% 0% 18% 61% 18% 3% 0%
0/100 0% 1% 33% 53% 13% 0% 0%

After
10 Years $50 $75 $100 $150 $200
Stocks/ Less Than to to to to to More Than
Bonds $50 $75 $100 $150 $200 $300 $300
100/0 3% 8% 13% 22% 17% 20% 17%
75/25 2% 5% 12% 28% 22% 22% 9%
50/50 0% 2% 11% 44% 26% 16% 1%
25/75 0% 1% 10% 66% 22% 1% 0%
0/100 0% 1% 25% 66% 8% 0% 0%

May not be republished or distributed without permission. See www.folioboost.com for important disclosures.
 www.folioboost.com

After
20 Years $50 $75 $100 $200 $300
Stocks/ Less Than to to to to to More Than
Bonds $50 $75 $100 $200 $300 $500 $500
100/0 4% 6% 6% 24% 19% 21% 20%
75/25 3% 4% 4% 30% 25% 22% 12%
50/50 0% 2% 4% 41% 35% 17% 1%
25/75 0% 1% 3% 69% 25% 2% 0%
0/100 0% 2% 16% 76% 6% 0% 0%

After
30 Years $50 $75 $100 $200 $400
Stocks/ Less Than to to to to to More Than
Bonds $50 $75 $100 $200 $400 $700 $700
100/0 3% 3% 7% 12% 26% 20% 29%
75/25 1% 2% 3% 20% 30% 25% 19%
50/50 0% 1% 2% 19% 49% 26% 3%
25/75 0% 0% 2% 40% 54% 4% 0%
0/100 0% 2% 9% 71% 18% 0% 0%

And here are the median expected terminal values, again inflation adjusted:

After 5 Years After 20 Years

Stocks/ Odds Odds Stocks/ Odds Odds

Bonds Median Up Down Bonds Median Up Down
100/0 $126 67% 33% 100/0 $249 84% 16%
75/25 $123 72% 28% 75/25 $233 89% 11%
50/50 $120 77% 23% 50/50 $205 94% 6%
25/75 $114 82% 18% 25/75 $168 96% 4%
0/100 $106 66% 34% 0/100 $129 82% 18%

After 10 Years After 30 Years

Stocks/ Odds Odds Stocks/ Odds Odds

Bonds Median Up Down Bonds Median Up Down
100/0 $158 76% 24% 100/0 $397 87% 13%
75/25 $152 81% 19% 75/25 $350 94% 6%
50/50 $142 87% 13% 50/50 $292 97% 3%
25/75 $129 89% 11% 25/75 $216 98% 2%
0/100 $113 74% 26% 0/100 $145 89% 11%

May not be republished or distributed without permission. See www.folioboost.com for important disclosures.
 www.folioboost.com

So, did we learn anything useful about risk and reward of equities? Yes.

The result many people fear the most is being down more than 25% (inflation adjusted) at the
end of their time horizon, represented by the first two columns in the first set of tables. With a
20 year time horizon, for example, we can see that using our assumptions, there is a 10%
chance of this with 100% equities and only a 2% chance with a 50/50 stock and bond portfolio.

On the other hand, there is a 41% chance of being up more than 200% (represented by the two
far right columns) with 100% equities and only an 18% chance with a 50/50 portfolio.

So, is an extra 8% chance of being down more than 25% worth the extra 23% chance of being
up more than 200%?

That is up to each individual.

For some, the potential for extra gains will make a huge difference. Others simply will not want
to take any extra risk.

There are a few things we can say with a lot of confidence.

• For any time horizon greater than a few years, unless you absolutely can’t take any risk,
having at least 25% stocks is better than having all bonds.
• The best chance for very high returns is 100% equities. But even 75% equities provides
for a lot of upside potential. Below that, it starts to drop fairly quickly.
• Generally, the odds of losing more than 50% over a long period of time are very small no
matter what your allocation.

Hopefully these charts help people better understand the implications of different asset
allocations.

Please keep in mind that they are based off mathematical models and are not subject to the
uncertainties of real life. If the world changes significantly, equity markets may no longer be
considered safe and greater losses may occur.

May not be republished or distributed without permission. See www.folioboost.com for important disclosures.