Maybe you should not buy ANY bonds in your retirement account.

Imagine a simple scenario where you are putting away $1,000 per year for retirement.  Bonds are notoriously stable, and stocks are notoriously volatile but provide higher returns.  How should you allocate between them?

The most common rule is “your equity allocation should be 120 minus your age” – which would put my allocation at 74% equities, 26% bonds.  I’m about twenty years away from retirement, so this number should glide path towards 46% bonds as I age.

This historically would have been horrible advice.  Here are the actual real returns for 10-year periods where $1,000 is invested in a portfolio every year.  The blue line represents an 80/20 stock/bond allocation (even more aggressive than the one recommended for me).  The orange line represents the returns of someone who puts 100% in stocks every year.

41% of the time, the 80/20 portfolio lost money.  The 100% stock portfolio only lost money 5%of the time.  The average money you have after 10 years of investing is $11,329 in the mixed portfolio, and $18,336 in the 100% stock portfolio.  In a grand total of 2 of the 85 periods, the mixed portfolio did better than 100% stocks, and by a trivial amount.  Following the120-your age rule would have been an outright disaster relative to the simpler “invest 100% in stocks until you are really close to retirement”.

Let’s say I use a 20 year horizon instead, much closer to my current timeframe.  There are a total of zero periods where it was better to diversify 20% into bonds.  The average money you have after 20 years of investing is $29,177 in the mixed portfolio, and $79,889 in the 100% stock portfolio.  That tiny diversification completely has destroyed your returns – you lose 64% of your wealth.  Isn’t that the real risk?

While it’s possible that the next twenty years look different from the last 100 or so, I’m not willing to bet on that.