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Overinvesting in Bonds: Why a 90/10 Stock-to-Bond Split Outperforms
Many financial advisors advocate a 60/40 stock-to-bond portfolio, citing bonds' counterbalancing effect during market volatility. However, this conventional wisdom often leads to underperformance. A 90/10 stock-to-bond allocation, favoring equities,
The 60/40 Portfolio Underperforms
Many financial advisors guide clients toward a 60% stock and 40% bond allocation. While stocks are volatile, bonds are positioned as a counterbalance during market downturns. However, this allocation often leads investors to hold too much in bonds, limiting overall portfolio growth.
Individuals preparing for retirement or needing to liquidate assets for substantial expenses, such as USD 6.74 million in living costs, often prioritize higher-quality bonds. Yet, this approach may not be optimal for large portfolios. Households with USD 1.07 million or more in investable assets, or other wealthy households, often benefit from an alternative strategy.
A common recommendation is to keep 60% of assets in stock. For affluent investors, a 90/10 stock-to-bond split, where 90% is allocated to a low-cost stock index fund and 10% to a money-market fund, is more effective for long-term growth by avoiding missed stock market upside and uncompensated expenses.
The Argument for a 90/10 Split
The 90/10 portfolio eliminates fees associated with financial advisors who typically charge 1% of assets under management. Constructing a 90/10 portfolio involves buying an index fund and a money-market fund, rebalancing annually irrespective of stock performance.
Historical stock price data supports the 90/10 allocation. Over multiple periods ending December 31, 2025, the average annual total return (with income reinvested) for the S&P 500 significantly outpaced that of 10-year U.S. Treasury bonds. The S&P 500 posted an average annual return of 7.33% through March 30, largely due to a post-Iran War bounce, with the index gaining 5.62% for the year by May 1. In contrast, 10-year U.S. Treasury bonds returned 0.89% over the same periods. Despite this, stocks consistently outperformed bonds across 20, 30, 40, 50, and 60-year periods ending 2025. A USD 100,000 investment in a 90/10 portfolio for 10 years would have accumulated USD 356,000, compared to USD 243,000 for a 60/40 portfolio. For 40-year horizons, the figures were USD 5.8 million versus USD 2.5 million.
The S&P 500's return is not dependent on market timing or sentiment but reflects the aggregate fundamentals of publicly traded U.S. companies. Bond returns are driven by interest rates, macroeconomic conditions, and government policies.
Bonds Underperform and Carry Tax Disadvantages
Stocks historically outperform bonds during periods of high inflation. Between 1972 and 1982, when annual inflation averaged over 8%, the average annual nominal total returns of the S&P 500 were 7.74%, while 10-year U.S. Treasuries yielded 5.71%. From 2021 to 2024, when annual inflation averaged almost 5%, U.S. Treasuries yielded 13.47% and were negative 5.35%.
For over a decade after the 2008 financial crisis, the bull run in bonds faded as interest rates normalized, and inflation pressures built. The federal government's increasing debt further influences bond performance, as it issues more debt at higher rates.
Bonds also carry tax disadvantages. Interest on bonds is taxed as ordinary income, at a top federal rate of 37%. Although municipal and Treasury bonds offer tax exemptions for some interest, dividends and long-term capital gains from stocks are taxed at a top rate of 23.8%.
Why the 90/10 Strategy Prevails
Two main arguments support the 90/10 portfolio over the past 60 years. First, the stock market's resilience despite crashes. The S&P 500 was negative for 13 of those 60 years, with the worst total returns occurring in 2008, 2002, and 1974. Each time, the S&P 500 posted strong positive returns in the subsequent two years.
Second, bond returns in fixed income are often lower. In 2022, when the S&P 500's total return was negative 18.04%, U.S. Treasuries were also down nearly as much. For fixed-income investments, the top federal rate on interest income is 37% (though municipal and Treasury bonds may offer tax exemptions for some interest). Dividends and long-term capital gains are taxed at a top rate of 23.8%.
In the past six decades, the S&P 500 experienced three consecutive negative years only once, during the dot-com bubble burst from 2000-02. However, these losses were more than recouped by the end of 2006. The S&P 500 was also down in both 1973 and 1974 by a total of 37.25% due to the oil embargo.
Those losses were more than recouped by the end of 1976. Bond returns were positive in only 10 of the 13 years when the S&P 500 was negative. In 2022, when the S&P 500's total return was negative 18.04%, U.S. Treasuries were down nearly as much.
Conventional wisdom suggests investors reduce stock exposure and increase bond holdings as they approach retirement. However, rising life expectancy extends their investment horizon, and households with USD 1.07 million or more in investable assets should pass on a substantial portion of their assets. Because of the step-up in basis at death, children inheriting these assets are not liable for taxes on capital gains earned during their lifetime.
For investors adopting a 90/10 portfolio, a plan to manage market downturns is essential. Historical data shows that stock market corrections follow distinct patterns. The first year of a drop in stock prices is typically followed by 30 years of returns, and significant declines often present buying opportunities. A money-market fund within the 90/10 framework provides liquidity during such events, unless the S&P 500 falls for more than a year.
Maintaining a lifetime portfolio primarily composed of a stock index fund and a money-market fund is crucial for maximizing growth.
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