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Authors: Peter Lynch
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half in 10 years, and cut two-thirds in 15.
So at some point in their retirement, our generic couple may be forced to cancel some of the trips they wanted to take, or they may have to spend some of their capital, which reduces their future income as well as any inheritance they planned to leave to their children. Except among the very rich, the good life cannot long be preserved without stocks.
Obviously, how much you should invest in stocks depends on how much you can afford to invest in stocks and how quickly youâre going to need to spend this money. That said, my advice is to increase the stock part of the mix to the limit of your tolerance.
I proposed as much to the trustees of the nameless organization. Before they decided to remodel the portfolio, the mix was 50 percent stocks and 50 percent bonds. The bond portion (invested in five- to six-year maturities) was yielding about 9 percent at the time, and the stock portion was giving them a 3 percent dividend, so the combined portfolio had a 6 percent return.
Normally, bonds are held to maturity and redeemed for the original purchase price, so there was no potential for growth in that half of the portfolio. The stock portion, on the other hand, could be expected to increase in value at 8 percent a year, above and beyond the dividend.
(Historically, stocks return nearly 11 percent, 3 percent of which is dividends, and 8 percent of which is due to stock prices going up. Of course, the big reason that stock prices go up is that companies continue to raise their dividends, which in turn makes stocks more valuable.)
With 50 percent of the money invested in stocks that grow at 8 percent, and 50 percent in bonds that donât appreciate at all, the combined portfolio had a growth rate of 4 percentâbarely enough to keep up with inflation.
What would happen if we adjusted the mix? By owning more stocks and fewer bonds, the organization would sacrifice some current income in the first few years. But this short-term sacrifice would be more than made up for by the long-term increase in the value of the stocks, as well as by the increases in dividends from those stocks.
What you can expect to gain in growth and lose in income by adjusting the percentages of bonds and stocks in any portfolio is shown in Table 3-1 . These numbers were crunched on my behalf by Bob Beckwitt, who has turned in a winning performance at the Fidelity Asset Manager Fund, which he runs.
Beckwitt is one of our resident quants. A quant is a complex thinker who deals in concepts beyond the grasp of most linear imaginations, and speaks a language that is understood only by other quants. Beckwitt is a rarity: a quant who can switch out of quant mode and communicate in normal English.
In all three scenarios analyzed by Beckwitt, $10,000 is invested. Weâre assuming here that the bonds are paying 7 percent interest and that the stocks are paying the current 3 percent dividend, and appreciate at the standard 8 percent a year.
In Case A, the entire $10,000 is put into bonds. In 20 years, the owner of this money will receive $14,000 in interest income, and then get back his or her original $10,000.
In Case B, the $10,000 is divided 50/50 between bonds and stocks. The result after 20 years is that the owner receives $10,422 in interest income from the bonds, plus $6,864 in dividend income from the stocks, and ends up with a portfolio worth $21,911.
In Case C, the entire $10,000 is put into stocks. Here the owner gets $13,729 in dividend income from the stocks, and ends up with a portfolio worth $46,610.
Since dividends continue to grow, eventually a portfolio of stocks will produce more income than a fixed yield from a portfolio of bonds. Thatâs why after 20 years in Case B you actually receive $3,286 more in income than in Case A, and in Case C youâre only losing $271 in income to get the full benefit of all the appreciation from putting your entire bankroll into stocks.
If you take
So at some point in their retirement, our generic couple may be forced to cancel some of the trips they wanted to take, or they may have to spend some of their capital, which reduces their future income as well as any inheritance they planned to leave to their children. Except among the very rich, the good life cannot long be preserved without stocks.
Obviously, how much you should invest in stocks depends on how much you can afford to invest in stocks and how quickly youâre going to need to spend this money. That said, my advice is to increase the stock part of the mix to the limit of your tolerance.
I proposed as much to the trustees of the nameless organization. Before they decided to remodel the portfolio, the mix was 50 percent stocks and 50 percent bonds. The bond portion (invested in five- to six-year maturities) was yielding about 9 percent at the time, and the stock portion was giving them a 3 percent dividend, so the combined portfolio had a 6 percent return.
Normally, bonds are held to maturity and redeemed for the original purchase price, so there was no potential for growth in that half of the portfolio. The stock portion, on the other hand, could be expected to increase in value at 8 percent a year, above and beyond the dividend.
(Historically, stocks return nearly 11 percent, 3 percent of which is dividends, and 8 percent of which is due to stock prices going up. Of course, the big reason that stock prices go up is that companies continue to raise their dividends, which in turn makes stocks more valuable.)
With 50 percent of the money invested in stocks that grow at 8 percent, and 50 percent in bonds that donât appreciate at all, the combined portfolio had a growth rate of 4 percentâbarely enough to keep up with inflation.
What would happen if we adjusted the mix? By owning more stocks and fewer bonds, the organization would sacrifice some current income in the first few years. But this short-term sacrifice would be more than made up for by the long-term increase in the value of the stocks, as well as by the increases in dividends from those stocks.
What you can expect to gain in growth and lose in income by adjusting the percentages of bonds and stocks in any portfolio is shown in Table 3-1 . These numbers were crunched on my behalf by Bob Beckwitt, who has turned in a winning performance at the Fidelity Asset Manager Fund, which he runs.
Beckwitt is one of our resident quants. A quant is a complex thinker who deals in concepts beyond the grasp of most linear imaginations, and speaks a language that is understood only by other quants. Beckwitt is a rarity: a quant who can switch out of quant mode and communicate in normal English.
In all three scenarios analyzed by Beckwitt, $10,000 is invested. Weâre assuming here that the bonds are paying 7 percent interest and that the stocks are paying the current 3 percent dividend, and appreciate at the standard 8 percent a year.
In Case A, the entire $10,000 is put into bonds. In 20 years, the owner of this money will receive $14,000 in interest income, and then get back his or her original $10,000.
In Case B, the $10,000 is divided 50/50 between bonds and stocks. The result after 20 years is that the owner receives $10,422 in interest income from the bonds, plus $6,864 in dividend income from the stocks, and ends up with a portfolio worth $21,911.
In Case C, the entire $10,000 is put into stocks. Here the owner gets $13,729 in dividend income from the stocks, and ends up with a portfolio worth $46,610.
Since dividends continue to grow, eventually a portfolio of stocks will produce more income than a fixed yield from a portfolio of bonds. Thatâs why after 20 years in Case B you actually receive $3,286 more in income than in Case A, and in Case C youâre only losing $271 in income to get the full benefit of all the appreciation from putting your entire bankroll into stocks.
If you take
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