With interest rates high across Treasury bonds, municipal bonds, and corporate bonds, there comes a point where owning bonds becomes more attractive than owning stocks. The objective of this article is to figure out an appropriate stock allocation by bond yield for a better risk-appropriate return.
The 10-year Treasury bond yield surged to 5%+ in 2023 due to high inflation and the Fed aggressively hiking rates. Now the Fed started cutting rates in September 2024, and will likely continue cutting for a couple years as inflation moderates.
Let's look at the suggested stock allocation by bond yield for investors looking to invest in a risk-appropriate way. We'll revisit history as an example.
Historical Stock Allocation By Bond Yield
Below is an interesting chart that shows the average allocation to stocks during different rate regimes. When the 10-year bond yield is between 4% to 4.5%, the average stock allocation is roughly 63%. But when the 10-year bond yield is between 4.5% to 5%, the average stock allocation actually goes up to 65% before declining.
Subramanian says, “based on several tested frameworks, 5% is the level of the 10-yr Treasury bond yield at which Wall Street’s average allocations to stocks peaked, and so is their expected return of the S&P 500 over the next decade.”
I get why the bar charts would fall (lower stock allocation) after the 5% level. But it's interesting to see how the stock allocation is lower when rates are between 1% – 4.5%. It's also interesting to see how there is an uptick in stock allocation once the 10-year bond yield surpasses 9.5%.
My guess is that at several points between 1985 – 2018, despite low risk-free rates, investors were simply too afraid to invest aggressively in the stock market because there was some type of financial catastrophe going on. During the start of the pandemic, the 10-year bond yield dropped to 1% due to a flight to safety. In other words, investors preferred holding a bond that yielded just >1% versus potentially losing 10% – 50% of their money holding stocks.
The Bond Yield Level Where I'd Switch
It has generally been OK to invest in stocks in a rising interest rate environment up to a point. A rising interest rate environment means there is inflationary pressure due to a tight labor market and strong corporate profits. Given corporate profits are the foundation for stock performance, a rising interest rate environment is an epiphenomenon.
At a 4.5% 10-year Treasury bond yield, I would go 50 stocks / 50 bonds. At 5%, I would go 40 stocks / 60 bonds. If yields rise to 5.5% I would go 30 stocks / 70 bonds. And at 6%, I would go 20 stocks /80 bonds. I stop at 6% since it's unlikely the 10-year bond yield will get there.
We know that based on history, a 50/50 weighting has provided a decent ~8.3% compounded annual return. A 60/40 stocks/bonds allocation provides a slightly higher historical compound return. Not bad, even if the returns are slightly lower going forward.
Bond Allocation Depends On Your Age And Stage In Life
But remember, you're not me.
I'm more conservative than the average 46-year-old because both my wife and I are both unemployed in expensive San Francisco with two young children. I cannot afford to lose a lot of money in our investments because I'm determined to be an SAHD until our daughter goes to kindergarten.
At a ~4.2% 10-year bond yield, we're now at the popularly espoused retirement withdrawal rate where you will maximize your take and minimize your risk of running out of money in retirement.
If you can earn 4.2% risk-free, that means you can withdraw 4.2% a year and never touch principal. Therefore, perhaps you want to have an even lower stock allocation than 50%. Here's a more detailed post about how risk-free rate affects safe withdrawal rates in retirement.
A 40% equities / 60% fixed income portfolio that has returned a historical 7.8% compound annual return since 1926 sounds quite reasonable. Of course, past performance is no guarantee of future performance.
See: Historical Investment Portfolio Returns For Retirement
Suggested Stock Allocation By Bond Yield
Eventually, higher rates will slow down borrowing because it makes borrowing more expensive. As a result, corporate profits and the stock market will decline, all else being equal. There is generally a 12-24-month lag after the Fed is done hiking where the economy begins to obviously slow down.
Based on historical Wall Street stock allocation data, historical inflation rates, and historical returns, here is my suggested stock allocation by bond yield to consider.
The suggested allocation percentages are for steady-state portfolios that planned to be invested for years as opposed to a house downpayment fund. Preferences will obviously vary, so use the chart as a gut check and make your own decision.
The goal is to always balance risk and reward. You should try and invest as congruently as possible with your risk tolerance. The investor who tends to blow themselves up generally underestimates their true risk tolerance.
Of course, in a rapidly changing interest rate environment, changing your stock and bond asset allocation so quickly may not be prudent. There are tax consequences if you're rebalancing in a taxable portfolio. Hence, you must try to anticipate where interest rates are going and asset allocate accordingly.
For example, let’s say the 10-year Treasury bond yield is at 4.2%. If you believe it is going to 3.5% in one year, you may want to shift your stock allocation from 45% to 60%. The thing is, bonds will likely perform well if rates move down as well. Finally, don’t forget to pay attention to inflation and real interest rates.
Much Higher Bond Yields Are Unlikely
Inflation peaked at 9.1% in mid-2022 and there are plenty of signs the economy is slowing. Therefore, I don't think the 10-year bond yield will reach 5%. It may hit 4.5%, but that's about the upper limit given we've already gone through 11 rate hikes.
The more likely scenario is that the 10-year Treasury bond yield starts to fade within 12 months. In the process, the yield curve begins to steepen as the Fed finally starts cutting rates.
I still think there will likely be another recession, but another shallow one that doesn't last longer than one year.
The majority of you have likely seen your net worths double or more since the 2008 financial crisis. As a result, the return on your larger net worth no longer needs to be as great to return the same absolute dollar amount.
Hence, I think it's worth following staying disciplined with your stock allocation based on bond yields.
Asset Allocation Depends On Net Worth Growth Targets
Your asset allocation also depends on your net worth growth targets. The lower your net worth growth target, the more conservative your asset allocation can be.
When I left my day job in 2012, I decided to aim for a 5% annual rate of return on my after-tax investment portfolio. It sounds low now, but back then, the risk-free rate was closer to 2.5%.
With a larger net worth today due to the bull market, luck, and some hustle, all I need is a 1% annual return to match the absolute dollar amount I desired in 2012. But by the Power of Grayskull, I can now get 4.2% – 5.4% risk-free return. This is a huge boon in this high interest rate environment. It is only logical I reduce my stock exposure.
All of you should go through the exercise of figuring out your asset allocation at different 10-year bond yield levels. Run your investments through an Investment Checkup tool to see what your current asset allocation is compared to what you want. Asset allocations can shift dramatically over time.
Good-enough investing is all about understanding different scenarios and managing your risk. You might like conservative returns with lower risk because you're retired. Or you might be fine with a higher allocation to stocks because you're still in the capital accumulation phase.
Everybody's financial situation is different. Make sure your stock and bond allocation make sense based on your goals and the current economic environment we're in!
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Hello Would really appreciate a reply, on this personal note. I am age 60s, have $1.75M, and no debts other than a low-interest mortgage (2.4%). With a pension and Social Security, I still need about $50K a year to maintain the budget. However, with CDs in the 5+% range, I put most of my money on a ladder spread across Roth, Traditional IRAs, and Rollover IRAs. Even cash is at 4.97% for now. The CDs are a short-term investment with some coming due at 3mo, 6mo, 1 yr (5.4%), and 2 yr (5.01%). For most of them, I am flipping to monthly coupons where I then move the interest payments to High Yield Dividend stocks (ET), ETFs (FALN), or Mutual Funds (FFRHX). If I can get income to $100K annually, I can beat inflation, cover my budget and have some serious money left over, without touching the principal balance. (unless I need a new roof, operation or other emergency). Am I playing with fire on these investments like JEPI, etc? I check the technical, and history of payment and deal with some losses/volatility. I read your newsletters and value your opinions/thoughts. Note, I was invested in a diversified portfolio and made some money in semiconductors in a 60/40 split. I am not in any growth stocks now, as income is my focus now. Do you think I am going too far away from equities? I am modeling the CD, Dividend investments, and cash to balance and ~6% is all I need to maintain. In the long term, it will be a challenge, but I can’t take the equity rollercoaster anymore just to average 7% over the years. Rick
Hi Sam. I’m interested in long term municipal bonds (10-20 year term) as opposed to Treasurys as it will equate to a better return in my tax bracket. I know you’ve previously reported on the unlikelihood of default in these assets by credit rating but does that length of term add more risk even if it’s a highly rated bond? Or do you recommend a better strategy for someone looking to lock in these high tax free interest rates for the long term? Thanks
I am attempting to digest and sync this advice with your recommendations for those in the capital accumulation phase. I am 34 years old and like to be hands off as much as I can with investing so I stay focused with index funds. I am extremely concentrated in stocks (95%+) across taxable and tax advantage accounts but I do have a full year emergency fund for a rental property mortgage and 6 months emergency fund (both in MMFs and CDs) if something were to happen. Currently only have about $11K in iBonds and a CD.
No kids, dual income in a HCOL area (renting), and roughly $1.2M in assets. Should I be thinking about having more bonds at my age/situation or keep focused on long term investing with high stock exposure given a long term horizon?
Love your work. Thanks!
Without knowing your full financial goals and income situation, it’s hard to say. But a current recipe rates, I think bonds are more attractive than stocks.
If you plan to work for 20+ more years, I think your allocation is OK. And here’s another article that’s worth reading on quantifying your risk tolerance.
Are you planning to sell some of your iBonds now that those yields are starting to come down? Or are you taking the position that inflation will stay elevated longer term and / or holding them as a hedge to that?
Yes. In fact, just sold $11,000+ the other day to use for my house purchase fund.
Treasuries at 5%+ look great.
Sam
Question- I plan on buying longer duration bonds once the yields are 4.75 and higher.
My plan is to sell them when interest rates drop in several yrs to get capital appreciation on the bonds as they will be in a tax free Roth acct.
My question is, to get the max appreciation I was thinking of buying 30yr bonds.
Are there any downsides that I am not seeing in this vs buying 10 yr bonds? Everyone talks 10 yrs. Seems 30 yr would be much higher return (assuming rates don’t go much higher). I don’t have an issue with keeping them to maturity as my ballast to my tech allocation.
Yes, longer duration bonds will rise more in principal value if rates drop. But they will fall more if rates rise. Powell just signaled a potential 12th rate hike in December 2023.
So I would allocate a percentage to 30-year bonds, but not all. It does feel like 2023 is the end of higher rates, and buying more bonds now could pay off.
But nobody knows! Hence why we invest based on probabilities and diversify accordingly.
Thank you
I’ve been buying a lot of the 20 year treasuries. It seems like the yield is in the sweet spot compared to the 30 year. I’m a bond novice however, so maybe there are things I’m not seeing/aware of.
Either way, good luck. I’ve largely been doing the same things as you (buying longer dated treasuries)
I love this article but get confused about how to allocate stocks/bonds in my personal holdings.
As a business owner, I have restricted stock. It is very illiquid so not like a regular stock. However, it is an extremely well run business and it consistently distributes 20-30% dividend for 10+ years now. So in that way it acts like a great bond. It also appreciates about 5-10% in principal. Would you all view it as a stock or a bond, or an “Alternative”? Maybe like a junk bond since it is tied to a business that could have a rough patch? If I identify it as a stock it appears that I am way overweighted in stocks – when combined with my other stock funds in taxable and retirement accounts.
Also, my vanguard money market is yielding 5.27% so it is loaded up, but of course Empower identifies that at “cash.” My treasuries yield 5.25% but they identify as a bond. Seems to me they both could be considered bond holdings?
I like viewing it as a bond plus. A greater principal growth component with steady income.
As a business owner, you know that very few other investments can compare to the value you can create yourself.
Cash at same yield as treasuries are like bonds. Just have to hold bonds to maturity to eliminate principal loss risk.
Bond+…I like it Sam.
What is your approach with zero coupon bonds such as the treasuries sold at auction on Vanguard? I too have been taking advantage of the higher yield by purchasing these treasuries but not sure I like getting paid all the interest up front with zero coupon bonds (if I was retired and living on the interest of bonds I think being paid monthly would be better).
And your advice on getting higher bond percentages in your portfolio in higher interest rate settings makes sense but only with individual bonds and not bond funds, correct? (the latter would have potential for loss in value depending on direction of interest rates)
Good enough investing should be the mantra for the remainder of the decade. The hangover from too low too long will take a while to work through, likely in weird and unpredictable ways. Why have all your money ride the waves when you can get guaranteed income?
I like bonds. Individual bonds. Treasuries. 18-36 months right now. No CA tax, pays 5%, as close to zero risk as you can get. With inflation falling and our family inflation lower than the printed, it’s even better.
Every couple of months some of my previous 6-12 months bonds mature and I just can’t find a better risk/return right now. I don’t have it all in bonds, but it’s just easy money for now. Thanks for writing about them!
I have a large position in Vanguard Wellesley Income (IRA). Last year it had one of its worst years ever-down 9%. Its allocation is roughly 40/60 stocks/bonds. Hoping for better over the next few years.
Sam
Question- I plan on buying longer duration bonds once the yields are 4.75 and higher.
My plan is to sell them when interest rates drop in several yrs to get capital appreciation on the bonds as they will be in a tax free Roth acct.
My question is, to get the max appreciation I was thinking of buying 30yr bonds.
Are there any downsides that I am not seeing in this vs buying 10 yr bonds? Everyone talks 10 yrs. Seems 30 yr would be much higher return (assuming rates don’t go much higher). I don’t have an issue with keeping them to maturity as my ballast to my tech allocation.
My stock allocation has grown in comparison to my bond exposure. I’m due for a rebalance from the performance and also change in the markets. Off the top of my head I should increase my bond exposure by roughly 10%. Time for me to go check in detail now. Thanks for the impetus!
I refer back to this post regularly as rates continue to rise. We are now at 4.6% on 20 year treasuries. I’m a big believer of individual municipal bonds in my taxable accounts (I’ve steadily increased my allocation in taxable) but now these treasury yields are attractive for my tax deferred. Have your asset allocations changed or are you more heavy bonds/treasuries as you suggested?
Hi Shannon, yes, I am actively building a Treasury bond and municipal bond portfolio now. Loving these higher interest rates!
Related post: How I’m Investing $250,000 Today
I found the historical risk/return data for the different asset allocations to be very informative. I’d love to see some additional data in that regard, specifically something like best/worst 5-yr, 10-yr, 15-yr, and 20-yr returns for those same allocations. I think this data could be very helpful for folks age 40 and up who may have to start thinking about tapering down their equity exposure.
If you have a data source and can provide a link, that would be fantastic.
I bookmarked this post because I expect to lean back on this information as the rates change. I have started to do that more often with your posts. The reason is simple, the advice is clear and makes sense. It also saves me the time in doing the math for a lot of these. The trick for me is doing the periodic assessments of my risk tolerance, and adjusting my portfolio when that changes due to my evaluation of the economic indicators.
What are your thoughts in keeping your bond allocation in a money market yielding 5% instead? That way you don’t lose principal when interest rates rise. Or is there something else I am missing here?
Read Sam’s articles on individual bonds.
Better than money market if you have state income tax, and principle is guaranteed (or as close to 0 risk as you can get) if you keep to maturity.
I like 18-36 months right now. All close to 5%.
I’ve always been surprised by such a high bond allocation. If your business is generating enough income to cover your expenses, wouldn’t your investment timeline theoretically be forever? Or at least until you sold your business or it declined.
I run an Internet business and have about 80% of my investments in stocks, 15% in real estate, and 5% in high interest savings accounts. My business produces way more than I need to live on. But even if that wasn’t the case, my passive investments also produce enough income. That makes my investment timeline very long so I wouldn’t have to sell in a crash.
Couldn’t the same be said for retirees with social security and government pensions that cover their expenses? My parents have both so they will probably never need their investment money, unless they decide to splurge.
It depends on how much you had and how much you lost during the 2000 and 2008 downturns? How did you do?
Eventually you want to use your money for something. Otherwise, there’s no point in investing and saving all these years.
I lost a lot during the market downturns, but since my time horizon is so long, I didn’t sell. In fact, I bought a lot more.
It would be a different story if I needed the money within a few years.
At current Yield level, things start to get interesting. People can build reasonable portfolios based on their preferences and risk tolerance. Your suggestion presents a good starting point. Thanks for sharing!
Here in Switzerland, we have a much worse situation. Yields are still very low, even negative… so… there is not much one can do to build a reasonable portfolio. To make things worse, the SMI itself is not really diversified (a few companies hold half the allocation).
Thanks- super helpful. AND… although I am positioning myself with an after-tax account that could sustain early retirement, I know that my wife will work for a lot longer than me and likely into her 50s. AND, thankfully, we can support our lifestyle with only her income. Therefore, does it still make sense to structure my after-tax account as you mention in the short term, or can I leave it in a much more aggressive stock-focused portfolio for maximum long-term returns knowing it likely won’t be touched. If it helps, I am 39. Thank you.
Kyle,
One of the keys to early retirement is to get your spouse to work longer so you can be free. Check out: How to make your spouse work longer so you can retire earlier. Some great tactics are in there from spouses I’ve spoken to.
You can be slightly more aggressive, but not so much so, especially since you plan to retire early.
Cheers, Sam
Good day, Sam,
I’m a huge fan. I have scoured the site and can’t find what funds you hold your pre and post bond allocations? Can you please update me with your suggestions in 2018?
Hi George, b/c I’m based on California, I’ve bought individual California muni bonds, and the California muni bond ETF, CMF. There’s MUB for the national muni bond fund.
When I go to Hawaii, I’ll be looking to support Hawaii with Hawaii muni bond funds.
Okay, I did read that. Sorry to waste your time. I should have been more specific with my question: I live in VA- for those of us that don’t have muni state ETF (don’t know if any VA muni ETF) what would you do? A lot of blogggers recommendation the Vanguard total bond funds for the bond allocation.
What is the easiest way to get into 3.25 bonds without using the treasury direct account? any good etfs?
Can anyone help?
Where is my option:
I’ll always have the majority of my investment portfolio in BONDS no matter how high the market goes
Even when the 10-year bond yield was at only 1.5%?
Kinda tough to make money in that scenario. How old are you?
I think it depends on your time horizon. It also depends on how you want to adjust your portfolios of taxable/retirement accounts.
I sense this bull market is somewhat similar to the one of late 1990s. We have high flier new-tech stocks in artificial intelligence (AI), cloud computing and Internet of Things – these companies carry P/E multiple north of 200. Likewise, in late nineties, we had internet stocks with P/E north of 100. Since trees will not growing into sky forever, when music stops say 2020, we may experience a bear market that lasts very long. Mindful that we lost a decade of no-return of S&P from 2000 to 2010, I am not sure the long term projection of 7% return might not be applicable for the next 10 years.
For me, since I do not plan to touch retirement accounts for at least 12 -15 years, I am comfortable to keep 70/30 to ride out the potential “lost decade.” But I will definitely reduce stock holdings in my after-tax account when treasury rate hits 5%. I might have 40/60 allocation (40 into mostly growth/dividend stocks, 60 into muni and treasury).
BTW, treasury rate hit 5% in 2007. And we know what happened afterwards.
Retirees will LOVE a 5% 10-year bond yield. I know I would!
Know that my investments are earning a guaranteed 5% every year would be amazing. I’d just focus on generating active income for a fun supplement.
Too bad we ain’t going back to 5% ever again IMO.
Why not use the tax advantaged space for bonds?
Maybe you have said why in the past, not enough room?
Bonds are important if volatility is a big worry and you are banking on that income.
Seems to me that you have the ability to take more risk but no need…good for you!
Sam, what do you consider the most helpful texts on learning more advanced philosophies and tactics regarding investing? I apologize if you have already written a post on this. Thank you for the insights and for stimulating a lot of thought!
Loved this article- thanks for writing.
You’ve always had a spot for bonds, Sam. I haven’t the same, Although I live in Australia with a slightly different financial market and tax structures.
I hold paying down debt is similar to investing in bonds, and hold your FSDAIR (think that’s what it was called) with high regard.
In your view could this strategy be used as an alternative in a rising rate environment?
Hi Mo – FS-DAIR is for investing or paying down debt, and this strategy is 100% on investing. So you can take this strategy for the investing portion of FS-DAIR if you wish. I think you should always follow FS-DAIR if you have debt to pay down, no matter what.