The Impact of Asset Allocation over Time |
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One of the strongest arguments for asset allocation is that stocks and bonds tend to react differently to different economic climates. These two asset classes tend to perform inversely. When stocks are up, bonds tend to be down—and vice versa. If you have some of your money in each asset class, you may be able to moderate your losses without giving up too many potential gains.
Take a look at the impact that asset allocation can have on your earnings.
Suppose a hypothetical $100,000 portfolio was invested in different proportions in the three major asset classes for a year, producing average rates of return. Earnings for each allocation were calculated based on the average annual market return of stocks (10.4%), bonds (5.9%), and cash (3.7%) between year-end 1925 and 2007.*
| | Aggressive | Moderate | Conservative |
| Stocks | 80% | 40% | 20% |
| Bonds | 10% | 40% | 20% |
| Cash | 10% | 20% | 60% |
| TOTAL EARNINGS | $8,380 | $7,030 | $5,030 |
Now look at what happens with similar allocations in a period when the stock market loses value. In 2000, 2001, and 2002, average returns were significantly lower than the long-term average for large-cap stocks (– 14.4%), significantly higher for long-term corporate bonds (13.3%), and at the same level for cash investments (3.8%).*
| | Aggressive | Moderate | Conservative |
| Stocks | 80% | 40% | 20% |
| Bonds | 10% | 40% | 20% |
| Cash | 10% | 20% | 60% |
| TOTAL EARNINGS | -$9,810 | $320 | $2,060 |
*Source: Stocks, Bonds, Bills & Inflation 2008 Yearbook, Morningstar, Inc. Data is based on the S&P 500 Composite Index for stocks, Salomon Brothers Long-Term High Grade Corporate Index for bonds, and a U.S. Treasury one-bill portfolio for cash. Past performance does not guarantee future returns.
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