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Published by Fidelity Interactive Content Services

Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.

Why stocks are less risky than bonds

Stocks may be less risky than you think if you have a long time horizon. Here's why.

  • By Daren Fonda,
  • Fidelity Interactive Content Services
  • – 11/07/2013
  • Investing Strategies
  • Investing in Bonds
  • Investing in Mutual Funds
  • Investing in Stocks
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Everyone knows stocks are riskier than bonds. After all, stocks can tumble 40% over the course of a few months while a rough patch for bonds is a 5% slide.

But even if you can't stand the stock market's dips and dives, some recent studies suggest it may make sense to own more stocks — up to 100% of your portfolio — if you don't need the money for 20 years or more.

"Stocks aren't particularly risky if held for a long time," says Michael Finke, a professor of personal financial planning at Texas Tech University in Lubbock.

Finke recently co-authored a paper, Optimal Portfolios for the Long Run, to answer a classic question: What's the best mix of stocks, bonds and cash for investors with at least 20-year time horizons?

To find out, the researchers crunched 113 years of data on stock returns from 20 industrialized countries. They analyzed the returns across overlapping 20-year periods and plugged in formulas to see what the returns would look like for investors with various appetites for risk. They also factored in the "utility" to an investor of having the highest total portfolio value after 20 years.

The bottom line: To get "optimal" returns, even the most risk-averse investors should hold 71% to 80% in stocks. Moderate-risk investors should hold 81% to 90%, and investors with the highest risk tolerance should go all in, holding 91% to 100% in stocks.

Should you own more stocks?

Finke acknowledges that the study's conclusions may sound "crazy." And they shouldn't be taken as advice to dump your bonds and buy more stocks.

Indeed, while academic research may support loading up on stocks, investors need to consider personal factors.

For example, most advisers suggest trimming stock exposure as investors near retirement age and want more stable returns. If you need regular income, an optimal portfolio may include more bonds or other income-producing investments. And if your holding period is less than 10 years, some advisers suggest owning just 30% in stocks.

It's also crucial to know how you'd react if the market tumbled 30% in a short time — say six months. For many people, an "optimal" portfolio isn't one with the highest value after 20 or 30 years — it's one that lets them sleep at night.

"People care about short-term volatility," says Finke. "It makes them unhappy even if they're not spending the money." For these investors, it may make sense to hold less stocks since that may make them less likely to sell when the market is falling.

Time is on your side

If you can handle the bumps, however, studies do suggest that the risks of owning stocks drop over time.

Statistically, the market's average return typically bounces around by 21.7% over any 12-month period, according to research from Fidelity Investments. But that measure of volatility, called standard deviation, declines to 12% after three years. It drops to 8.8% after five years and dwindles to 1.4% after 30 years, according to Fidelity's research.

Essentially, that makes stock returns more stable than intermediate-term government bonds, which have a 2.5% standard deviation after 30 years.

Why are stock returns so volatile near-term and stable long-term? Investor behavior, for one thing. Despite lots of evidence that stocks are riskier in the near term, the average holding period for U.S. stocks is just one year, says Finke.

Further, markets are driven by short-term factors like changes in corporate profits and the outlook for the economy. These things bounce around quite a bit quarter-to-quarter, jostling the market. Eventually, though, economic factors revert to long-term averages and stock returns follow a similar pattern.

Granted, this idea of "time diversification" — above-average returns offsetting below-average returns and lowering the risk of owning stocks over time — is controversial.

Some economists say it doesn't really exist since it would violate basic laws of finance. If the theory is right, they argue, long-term investors can earn higher returns with less risk by owning stocks — getting a free lunch compared to assets like bonds or cash. That idea — getting something for nothing — isn't supposed to happen, according to economic theory.

Yet evidence for time diversification exists in the real world, says Finke. It's been apparent in U.S. stock returns for more than a century, he points out. And there's now evidence for it in global markets, according to his unpublished paper, Optimal Portfolios, co-authored with David Blanchett of Morningstar and Wade Pfau of The American College.

A balanced approach

Even if you're not comfortable holding more stocks there are ways to potentially enhance your returns.

Rebalancing, for example, can boost your long-term results. People have a tendency to become risk-tolerant during bull markets — buying stocks when prices are high. And they grow fearful in bear markets, selling when prices are low. To avoid that mistake, you should set a long-term target mix for your investments and rebalance your portfolio once or twice a year.

If you're unsure how to set up your portfolio, "balanced" funds can do it for you. These funds hold a mix of stocks, bonds and cash, and the managers adjust the mix based on their views of the market. The most conservative funds hold around 35% in stocks, on average, while the most aggressive hold roughly 80%.

Some top-ranked funds are listed below. These funds have above-average returns in their categories and receive top ratings from Morningstar based on risk-adjusted performance and other factors. As always, you should do your own research or consult an adviser before investing.

Conservative allocation

Fund                                                                                                                                             Expense ratio 30-day Yield Transaction fee
Berwyn Income Fund (BERIX) 0.68% 2.3% $49.95
Westwood Income Opportunity Fund (WHGIX) 0.91% 1.9% $49.95
Fidelity Asset Manager 40% (FFANX) 0.59% N/A None

Moderate allocation

Fund                                                                                                                                               Expense ratio 30-day Yield Transaction fee
Dodge & Cox Balanced Fund (DODBX) 0.53% 2.1% $49.95
Mairs & Power Balanced Fund (MAPOX) 0.75% N/A $49.95
Fidelity Balanced Fund (FBALX) 0.58% 1.5% None

Aggressive allocation

Fund Expense ratio 30-day Yield Transaction fee
Manning & Napier Pro-Blend Maximum Term Fund (EXHAX) 1.1% N/A None
Value Line Asset Allocation Fund (VLAAX) 1.15% N/A None
American Century One Choice Portfolio Aggressive Fund (AOGIX) 1.01% 1.4% None

Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article.

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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
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