A Balanced Approach: Less Risk, But Lower Potential Return
The annual return of the S&P 500 index has been 10% or higher in more than half the years from 1926 through 2010. However, in more than a quarter of the years for this period, the index delivered a negative return.
But an allocation to bonds has tended to dampen the volatility of an all-stock portfolio—while only somewhat limiting positive outcomes.
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For example, a balanced portfolio, composed of 60% stocks and 40% bonds, delivered annual returns above 10% almost as frequently as the S&P 500, but provided negative returns in slightly fewer than a quarter of the years.
As shown in Figure 1, the balanced portfolio’s annual returns were less widely dispersed from the stock market’s long-term average of 9.87%, as measured by the S&P 500.
Over the entire period, the balanced portfolio’s annualized return was 8.52%, or 13.7% lower than that of the all-stock portfolio, but it displayed a 40% reduction in risk as measured by the difference in volatility for the two portfolios.
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