Investment Allocations

As we see it, there are only a few true categories for investment choices available for retirement. Given our study of the history of all choices, we focus here on just four of the most common:  Cash investments, Bonds, Large Company Stock, and Small Company Stock.

Cash investments would be any investment where principal is stable and interest can vary, such as checking accounts, savings accounts, money market funds, or accounts, Treasury bills, Certificates of Deposit, etc. Large and Small stock would be a broadly diversified mix of all stocks in that category, generally held like an individual family business that you intended to keep for life. We have not included such choices as precious metals, most commonly gold. These would have dramatically failed so often as compared to the relatively small number of times they would have dramatically succeeded that they are not a compelling consideration.

Relying on the well-respected Morningstar® Publication, “Stocks, Bonds, Bills and Inflation, (SBBI) Classic Yearbook,” originally written by Dr. Roger Ibbotson and updated annually, we can get long-term historical performance data for all the major investment categories we want to look at going back to before the Great Depression.

Keeping it simple, if we round down to the nearest whole number and don’t yet account for the real world costs of investing, including taxes, we learn from this hugely valuable but terribly boring book that over thirty-year periods or longer, cash investments tend to earn on average about 4%, Bonds about 7%, Large Company Stock about 10%, and Small Company Stock about 12%. SBBI also tells us that inflation has been about 3%.

So if inflation gives us an average “current” of 3% that we must overcome, that would leave Cash investments with a before tax return of around 1% where potentially all of it could be lost to taxes, bonds with 4%, Large Stocks with 7%, and Small Stock with around 9%. We call this concept where inflation is taken out “real return,” as opposed to “nominal return” when inflation is not accounted for.

The obvious conclusion is that you need more of your money in investment choices that have with great consistency over thirty-year timeframes and longer given real returns like 7% to 9% than choices that tend to provide 1% to 4% before taxes if you want a meaningful and sustainable income in retirement.

It is important to understand that when we make this case for using stocks for the core holding in your long-term retirement income portfolio that we do not mean speculating on price fluctuations of individual companies by trying to buy and sell stocks. We are instead referring to owning thousands of the great businesses of the U.S. and the World by owning and holding them for life. One of the most important concepts here is that by doing so, in addition to owning the greatest businesses you will own some that perform poorly and some that fail. However, as a result of your broad diversification, you will also own the companies that put the failures out of business and benefit from their demise, thereby benefiting from the most fundamental principles of capitalism.

Past performance is not indicative of future returns.  Diversification does not guarantee investment returns and does not eliminate risk of loss.