I have decided to reduce the proportion of bonds and fixed income assets in my investment portfolio. I will explain why I have done this here. As a trade war seems to be brewing between the USA and China in recent weeks along with user privacy concerns in the Tech sector, stock market volatility has gone through the roof.
This has impacted stock investments, with daily up or down price swings of around 2% becoming frequent. In such times it seems to make sense to hold a lot of bonds to cut losses but I am going to go against this approach.
My initial thinking was to ensure that the bond allocation within my portfolio would be around my age and a bit less because I am not very risk averse. This meant a target of 20% in bonds and 80% in stocks which I have been following for a few years. These are held as UK Government bonds.
The bond amount had slid to roughly 17% as stocks have outperformed bonds as expected. Such an allocation is still considered very aggressive. However, as my assets increased to a substantial amount, I became more concerned about the opportunity cost involved with holding too much of low return assets.
A good investor acts on their concerns by researching, learning from the experts, figuring out how the knowledge relates to their personal situation and adjusting strategy accordingly.
A key attribute of being a good investor is to act on your concerns by doing your research, learning from the experts, figuring out how the knowledge relates to your personal situation and adjusting your strategy accordingly if needed. Here is how I followed these principles to address my bond concerns:
- Determining my risk tolerance. You only know your risk tolerance once you have experienced a bear market like the ones in 2008 or 2000. The previous quarter’s market volatility has provided a taste of what it is like to lose chunks of a portfolio and made me feel more confident to take on more risk in return for long term returns.
- Considering expert advice. As a confirmation of my thoughts, the advice of top investors was invaluable. Big ERN from Early Retirement Now breaks down how bonds can be riskier than stocks over the long run. Such advice was echoed by Warren Buffet in his latest letter. Jim Collins also recommends holding 100% stocks during the wealth accumulation phase which I am currently in.
- Knowing the assets. Holding stocks is owning fractional pieces of real world profit generating companies which tends to be valuable over the long term. In contrast, buying bonds is lending money to companies or governments in return for coupon payments. A benefit of bonds is that they tend to have a negative correlation with stocks so can smooth out volatility at the cost of low returns, but too much of them is not a good thing.
- Thinking holistically. Instead of being only focused on just investments in a brokerage account or ISA it is important to look at the overall net worth picture. This also includes any pensions, bank accounts, fixed income, real estate, businesses etc. Once I did this I realised that the bond allocation was too high.
Following this assessment, I decided to take action. I switched 14% of my current bond holdings to stocks. This has come at a good time as the stock market has dropped recently. In addition, all future monthly purchases will now be 100% stocks to maximise returns.
As a result, my investment portfolio’s shape has changed as shown above. I believe this will be a more effective strategy to achieve financial independence goals going forward.
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