When it comes to investing, it seems like most long-term success comes down to a few things.
First, you have to pick a reasonable asset allocation, which generally means investing in a broadly diversified portfolio (I recommend Total Stock Market Index Funds like VTSAX, FSKAX, or the like).
Second, once you’ve picked a reasonable asset allocation, you then have to either forget about your investments completely, or you have to have the willpower to not freak out when things get rough.
The willpower thing isn’t easy. I was a broke college kid back in 2008, so I never did get to see how I would react if all the money I invested dropped in value each day. I like to think that I would have had the willpower to hold tight, but I can’t really be sure. Sure, there have been dips and bumps along the way over the past decade, but nothing that has really tested my strength that much, so I can’t really be sure how I’ll act if there’s an extended stock market decline.
The solution to this willpower problem, I’ve always been told, is to allocate some percentage of your portfolio to bonds. The idea here is that bonds help smooth out the volatility that comes with stocks. When the market has a bad stretch, the portfolio that has some bonds in it won’t do as badly, and hence, the investor with the bond allocation will be less likely to freak out and sell everything.
This is not what I’ve done and indeed, since I started investing, I’ve gone with a 100% equity portfolio. My rationale is that I’m young and still deep in the wealth accumulation phase of my life. My goal is to get the highest returns possible over the long run. At this point, the only real reason for someone like me to have bonds is to reduce my chances of freaking out when the market takes a dip.
This leads to another question - does a bond allocation really help avoid freakouts?
Reasons For Bond Allocations
The typical recommendation from most experts is for the young investor to have at least a small percentage of their portfolio in bonds. Vanguard’s most aggressive Target-Date Funds have a 10% bond allocation. Robo-advisors like M1 Finance, Betterment, and Wealthfront also have a small bond allocation of 5-10% for young investors.
If you go to investing forums like the Bogleheads, you’ll find a lot of people explaining why you need bonds in your portfolio. People will say things like this:
- “[S]peaking personally and subjectively, it’s easy for me to overestimate my ability and willingness to take risk, so that without the stabilizing effect of having some bonds in the portfolio I would lose confidence and abandon an all-stock strategy during a severe stock market decline.”
- “[M]ost folks here recommend every investor–particularly novices–have at least some [bonds].”
This rationale has never made much sense to me. Most people wouldn’t advocate a young investor to have a large bond allocation in their portfolio. Instead, the suggestion is to have “some” bond allocation, which typically means something like 5% to 20% in bonds.
The problem is that such a small allocation really doesn’t do much. If the market tanks and your portfolio drops 50% which then causes you to freak out and sell everything, would you really not freak out because you had some bonds in your portfolio and your portfolio only dropped 35% or 40%?
That isn’t to say bonds are pointless. There are a few actual reasons for having at least some bond allocation that doesn’t have to do with reducing freakouts. The first is that having bonds does help with rebalancing. That is, if your stocks drop in value during a downturn, you can sell some of your bonds and rebalance your portfolio, allowing you to buy more stocks at a discount. The thing that doesn’t seem to make much sense about this is that historically, stocks go up more often than they go down. So if the point of bonds is just to be able to rebalance, it doesn’t seem to make much sense to me to keep a lower-earning asset class simply for the opportunity to buy stocks at a discount. Most of the time, you’ll just be waiting.
The second reason for bonds has to do with taking on risk and the level of return you get. There’s a concept in investing called the efficient frontier, which essentially means getting the highest rate of return at the lowest level of risk (I’m not an investing expert by any means, so forgive me if I butchered the explanation). The general idea is you want whatever return you get to be appropriate for the level of risk you’re taking. Putting everything you own into Bitcoin could make you really rich. But the risk you take by putting everything into it isn’t worth the return you’ll get.
There’s an argument that can be made that a 100% equity portfolio takes on too much risk for the return you get, which might justify having a small bond allocation during the accumulation phase. I admittedly can’t argue with that.
What Do Bonds Really Do For Your Portfolio During Market Crashes?
All that said, for most people, the main explanation for having bonds is to smooth out volatility. And the point of smoothing out volatility is to avoid the freakout moment where you sell everything because things are going bad.
But let’s see if this would really help you not freak out. Below is a chart showing the returns since 2008 for a 100% equity portfolio, a 90% equities/10% bonds portfolio, and an 80% equities/20% bonds portfolio.
What we can see here is that the difference between all of these portfolios was so negligible that it basically meant nothing for “avoiding freakout” purposes. Starting with a $10,000 portfolio, the 100% equity portfolio fell to $5,177 at its lowest point. The 80/20 portfolio fell to $6,108. I can’t see why someone would freak out seeing their portfolio drop 50%, but not freak out seeing their portfolio drop 40%.
When you look at the numbers, even a 50/50 portfolio would have dropped to $7,611 at the bottom of the financial crisis. Only a portfolio with 90% bonds avoided any major dip. And we can all agree that’s probably not a reasonable allocation for anyone building wealth.
What all this tells me is that a small bond allocation is not going to stop someone from freaking out. Whether a person freaks out or not is going to come down to them alone. It all going to come down to willpower.
Takeaways
The takeaway from all this is that how you handle market downturns and crashes is on you. It’s a mind game. Bonds aren’t going to save you.
For myself, I’ve opted for a 100% stock allocation. My rationale is that I believe that the market will go up over time and that companies will continue to grow and innovate. I have no choice but to believe that if I believe in capitalism.
But I also know it’s not going to be a smooth ride. Stuff will happen. Markets will go up and down.
The goal is to avoid freaking out when things get tough. If having some percentage of bonds does that for you, then that’s fine. Do what you have to do to not freak out. Just don’t freak out when the going gets tough.
More Recommended Ebike/Scooters
Check out these other ebikes/scooters I've had the chance to do a review for:
- GEN3 Outcross Bike – The GEN3 Outcross is a solid, affordable fat tire ebike that does a good job of doing what I need it to do. It works great for city riding, giving me a smooth ride in all conditions. It’s works really well as a winter ebike since the fat tires give it good traction over snow and ice. Check out my GEN3 Outcross Review.
- Himiway Escape Bike – The Himiway Escape is an interesting bike for anyone looking for a moped-style ebike. If you’re a gig economy worker, the Himiway Escape is particularly interesting and it’s possible to think of it as an investment, especially if you can opt to do deliveries with the Himiway versus using a car. It’s not cheap, but you can definitely make your money back when you compare the mileage you’ll put on your car versus using an ebike. Check out my Himiway Escape Bike Review.
- Espin Sport Bike – The Espin Sport is a good ebike for someone who is looking for an ebike that feels and rides more like a regular bike. There are many ebikes that are really only bikes in name. In reality, they’re basically electric mopeds. The Espin Sport, by contrast, is a bike you could probably ride without the battery and you’d feel like you’re just riding a regular bike. Check out my Espin Sport Review.
- Varla Eagle One Scooter – The Varla Eagle One is an excellent scooter that can make sense for a lot of people. It can work as a primary mode of transportation. You can use it to work on gig economy apps like DoorDash, Uber Eats, and Grubhub. And it can also be a recreational vehicle if you’d prefer to use it for that. Check out my Varla Eagle One Review.
- Fucare H3 Scooter – The Fucare H3 is a fun scooter and I’ve enjoyed testing it out. For a daily commuter or quick trips or errands, the Fucare H3 is probably the scooter I’ll use. It’s portable and easy to maneuver, so it’s just easier to take on the road when I need it. Check out my Fucare H3 Scooter Review.
More Recommended Investing App Bonuses
For additional investing app bonuses, be sure to check out the ones below:
- M1 Finance ($100) – This is a great robo-advisor that has no fees and allows you to create a customized portfolio based on your risk tolerance. You also get $100 for opening an account. Check out my M1 Finance Referral Bonus – Step-By-Step Guide.
- SoFi Invest ($25) – SoFi Invest is an easy brokerage account bonus that you can earn with just a few minutes of work. Use my SoFi Invest referral link, fund your SoFi Invest brokerage account with $100 and you’ll get $25 of free stock. I also have a step-by-step guide for the SoFi Invest referral bonus.
- Moomoo (5 free stocks) – Moomoo is a free investing app currently offering 5 free stocks (usually worth around $75-$100) if you open an account using a referral link and deposit $2,000. Read my Moomoo referral bonus guide for more information.
- Webull (5 free stocks) – Webull also gives you 5 free stock valued between $3-$3,000 each if you open an account using my referral link. Here’s a guide I wrote about how to earn your free stocks using Webull.
- Robinhood (1 free stock) – Robinhood gives you a free stock valued between $2.50-$225 if you open an account using my referral link.
- Public (1 free stock) - Public gives you a free stock valued between $3-$70 if you open an account using my referral link.
More Recommended Bank Account Bonuses
If you’re looking for more easy bank bonuses, check out the below options. These bonuses are all easy to earn and have no fees or minimum balance requirements to worry about.
- GO2Bank ($100) - GO2Bank is an easy bank bonus that I recommend people take advantage of if they have an easy way of meeting the direct deposit requirement. I like that it’s easy to open the account and that the bonus pays out quickly. Check out my step-by-step guide on how to earn your GO2Bank $100 referral bonus.
- Chime ($100) - Chime is a free bank account that offers a referral bonus if you use a referral link and complete a direct deposit of $200 or more. In practice, any ACH transfer into this account triggers the bonus. This bonus is easy to earn and posts instantly, so you’ll know if you met the requirements as soon as you move money into the account. I wrote a step-by-step guide on how to earn your Chime referral bonus that I recommend you check out.
- US Bank Business ($750) – This is a fairly easy bank bonus to earn, since there are no direct deposit requirements. In addition, you can open the Silver Business Checking account, which comes with no monthly fees. Check out how to earn this big bonus here.
- SoFi Money ($275) – SoFi Money is a free checking account from SoFi. They’re currently offering a $25 referral bonus if you open a SoFi account with a referral link and deposit $10. You can also make an additional $250 as well if you complete a direct deposit. This is a good bank that is also 100% free, so you won’t have to worry about managing this account. Here’s a post I wrote with instructions on how to earn your SoFi Money bonus: SoFi Money Referral Bonus: Step By Step Guide.
- Fifth Third Bank ($225) – This offer is limited to customers in the following states: Florida, Georgia, Illinois, Indiana, Kentucky, Michigan, North Carolina, Ohio, Tennessee, West Virginia, and South Carolina. If you don’t live in one of those states, you won’t be able to open an account online but you can still open an account in-branch if you happen to be visiting a city that has a branch. This is a fairly easy bank bonus to earn, especially since there are plenty of data points showing what will trigger the direct deposit requirement. In addition, you can open the Fifth Third Momentum Checking bank account, which comes with no monthly fees or minimum balance requirements. Read my guide on this bonus here.
- Fairwinds Credit Union ($100) – Fairwinds Credit Union is offering a referral bonus for users that sign up using a referral link. Fairwinds has no fees or minimum balance, so this is a particularly easy bonus to earn. Since this is a smaller credit union, my gut instinct tells me this offer won’t be around long, so if you’re in a position to meet the bonus requirements, grab this bonus before it’s gone. Here is my step-by-step guide on how to earn your Fairwinds Credit Union bonus.
- Netspend ($40 + 5% Interest Savings Account) – Netspend is a company that provides 5% interest savings accounts. If you sign up using my referral link, you’ll get a $40 signup bonus once you make your first deposit into your Netspend account of $40 or more. That means you get a 5% interest savings account and a free $40 to start! Make sure to check out my in-depth guide on how to set up these accounts.
- Current ($50) – Current is a free fintech bank that’s offering new users a $50 referral bonus after signing up for an account using a referral link.Current is an easy bonus to earn and also gives you access to three savings accounts that pay you 4% interest on up to $2,000. That means you can put away up to $6,000 earning 4% interest. That’s very good and makes Current an account I recommend to everyone. Check out my step-by-step guide on how to earn your Current Bank bonus.
- Digital Federal Credit Union ($20) – Digital Federal Credit Union (DCU) is a free, nationwide credit union that I recommend to readers for two reasons. First, DCU has a $20 referral bonus if you open a free DCU checking account with a referral link. Second, DCU has a saving account that gives you 6.17% interest on your first $1,000. Check out my in-depth post on how to set this account up.
- Novo Bank ($40) - Novo bank is a free business checking account that’s currently offering a $40 bonus if you open a Novo business checking account using a referral link. In addition to being a good bank bonus, Novo is also a good business checking account. It has no monthly fees or minimum balance requirements and operates a good app and website. Indeed, it’s the business checking account I currently use for this blog. Check out my post on how to easily open a Novo account.
- Varo ($30) – Varo is a free fintech banking app similar to Chime or Current. It’s currently offering a $30 bonus to new users that open a new Varo account with a referral link. The bonus for this bank is very easy to meet, all you need to do is spend $20 within 30 days of opening your Varo account. Check out my step-by-step guide to learn how to earn this bonus.
Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the gig economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer.
Kevin is passionate about earning money using the gig economy and you can see all the ways he makes extra income every month in his side hustle reports.
Kevin is also big on using the latest fintech apps to improve his finances. Some of Kevin's favorite fintech apps include:
- SoFi Money. A really good checking account with absolutely no fees. You'll get a $25 referral bonus if you open a SoFi Money account with a referral link, and an additional $250 if you complete a direct deposit.
- US Bank Business. US Bank is currently offering new business customers a $750 signup bonus after opening a new account and meeting certain requirements.
- M1 Finance. This is a great robo-advisor that has no fees and allows you to create a customized portfolio based on your risk tolerance. You also get $100 for opening an account.
- DCU. Digital Federal Credit Union (DCU) is a free, nationwide credit union that I recommend to readers for two reasons. First, DCU has a $20 referral bonus if you open a free DCU checking account with a referral link. Second, DCU has a savings account that gives you 6.17% interest on your first $1,000.
- Personal Capital. One of best free apps you can use to monitor your portfolio and track your net worth. This is one of the apps I use to track my financial accounts.
Feel free to send Kevin a message here.
I recall reading that 100% stock allocation was not the best return over the past 30 years. I can’t recall the exact allocation but I seem to have something like 85% stocks/15% bonds in my mind.
The reason I have about 35% bonds in my portfolio is because I am considering retirement soon.
I think the DJIA was down 12% last week. During the same period, my portfolio was only down 5%
Dan
Yeah, I feel like I’ve read that as well that some percentage of bonds had the highest return. But we know that as a rule, equities return more over time.
My main thing I never understand with bonds (and my thinking with this post) was how it stops someone from freaking out and selling everything. The market dropped 12% and some people freaked out and sold everything. If you had 10% bonds, your portfolio still dropped close to 12%. So ultimately, the small bond allocation really doesn’t do much in the avoiding selling at the bottom problem. That’s all about willpower in the end.
Okay, so I am not the only one skeptical of the importance of bonds. I guess we both are willing to take the risk. However, I noticed that your graph does not show numbers which predate the recession.
Yeah, my point was just to show how the big drop happens even if you have a small percentage in bonds. So what’s the point of 10% in bonds? If you’re going to freak out, you’re going to freak out. It comes down to willpower to not freak out.
100% stocks and no cash?
Good point. No, I have a $42,000 emergency fund that earns 5% interest, so it’s essentially a bond allocation.
I don’t keep that cash for the bond allocation aspect of it though. I keep it since my risk-free rate of return is so high on it and I like having an emergency fund.
Where are you getting 5%? In a high yield savings account or CD?
I have a little hack that lets me do this. See this post here for more info: Netspend 5% Interest Accounts
I was like you, 100% equities during accumulation phase. However a few years before retiring slightly early I started moving more into bonds. Now I’m only half stocks and the other half is bonds, cash, REITs, gold, commodities, etc. but mostly bonds. I can’t see that 10% bonds does much useful. But at my level I saw a much smaller drop than the market as a whole, of course I gain less too but once you’ve “won” the proverbial game there is not much reason to keep your franchise player on the field.
Yep, once you’ve won the game, you’re good. 50% bonds actually makes a difference when things drop a lot.
Great summary,
As you mentioned, personally I just think that re-balancing is probably the key and hence Treasury Bond ETFs and Aggregate Funds are probably most suited for the average investor (although arguably TIPS can be good in this market, too)
For your readers it might be helpful to go through the Bond Guide that I’ve written:
https://bankeronwheels.com/best-bond-etfs/
All the best,
Raph
Thanks for sharing!