How Much To Invest In Bonds?

Try Googling “how much to invest in bonds?“. Go on, I’ll wait. By my count, there are something like 200 million results!¬†That’s far too many for so simple an issue. Let me break it down for you.

Don’t Optimize, Satisfice

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Photo Credit: Elliott Brown

Many of us, especially the left-brained among us, like to think of ourselves as relentlessly rational optimizers. There’s no such thing as “good enough” for some people: it’s either perfect or it’s crap. Thus, we spend an absurd amount of time optimizing things having only tiny effects on the ultimate outcome of whatever it is we’re optimizing.

Unfortunately, investing provides fertile ground for this sort of counter-productive behavior. I have seen people agonize over whether they should invest 15% of their portfolio in bonds versus 20%. Or perhaps 10% in bonds and 10% in real estate? What about international bonds? Maybe 5% in those, as well?

I’m not saying such decisions don’t make a difference; clearly they do, but I am saying they don’t make a particularly¬†large difference in the grand scheme of things. Which is better: 20% in bonds or 25%? How about 30%? It’s impossible to know in advance, and since we can’t know the correct answer until after the fact, there’s little point making careful, targeted tweaks in this area because any change we make could just as easily hurt as help us.

How Much To Invest In Bonds?

Since one can’t possibly know the “correct” or “best” allocation to bonds ahead of time, we have to settle for what’s reasonable. And in general, the old rules of thumb more or less form the bounds of what’s reasonable. Specifically, if your allocation contains somewhere between (your age minus 20) and (your age) in bonds, your allocation is likely reasonable. So if you’re 35 years old and allocate between 15% and 35% of your portfolio to bonds, you’re probably doing it right. Whether your actual allocation is 15%, 22%, or 31.5% isn’t particularly important. What matters is that you’re within that acceptable range.

Of course, there are mitigating circumstances. If you’re a 25 year old billionaire, you may choose to invest much more conservatively. By the same token, somebody like Bill Gates may not care to own any bonds at all regardless of how old he is. There are certainly valid reasons to venture outside the bounds of the old rules of thumb, but you should only do so if you have a very specific reason. And let’s face it, if you have a firm enough grasp on the fundamentals of personal finance to intentionally venture outside the mainstream, you probably aren’t looking for advice on the internet to begin with.

My Bond Allocation Is…

I’m currently 31 years old and invest 10% of my portfolio in bonds. Some of you will immediately notice this falls ever-so-slightly outside the “reasonable” range mentioned above. My reason for doing so only serves to reinforce my original point, though. While I suppose I should technically be 11% in bonds at this point, that extra 1% just doesn’t matter. It literally isn’t even worth doing the 90 seconds of work it would require to reallocate my portfolio, so I’m just going to leave it alone for another few years. Instead, I plan on reallocating at 5 year intervals, meaning I’ll reallocate to 15% bonds when I turn 35. Fine-tuning your portfolio, after a certain point, just strikes me as a giant waste of time.

I will undoubtedly catch a lot of flack for my opinion on this. After all, asset allocation explains something 90% of the long-term performance of any portfolio. How dare I tell people the specifics don’t matter that much! Well, do the math. What are the odds that your agonizing over where to allocate the last 3% of your portfolio will appreciably improve your portfolio’s performance? They aren’t good.

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