Are you wondering whether to buy bonds to build wealth? Well, wealthier people in America do not follow the conventional asset allocation model of buying bonds, i.e. age equals your bond percentage allocation or a 60/40 equities/fixed income split. Nor do they follow my stock allocation by bond yield either.
How do I know this? Empower has over 1,000,000 users of their free financial dashboard to help manage your money and I'm a consultant who is privy to some of their data to share with all of you. Data geeks, rejoice!
Out of one million plus Empower financial dashboard users, roughly 200,000 of them have linked investable assets of between $100,000 to $2 million. We call this the mass affluent class, or upper middle class if you're so inclined. The mass affluent are generally regular folks with mainly W2 income.
They save and invest in order to provide for their family, pay for expensive tuition bills, take a couple nice vacations a year, and hopefully achieve a comfortable retirement when all is said and done. Interestingly, the mass affluent don't have a large bond allocation at all.
Let's do a quick review of my proposed stocks and bonds asset allocation model before moving on to the big data.
FINANCIAL SAMURAI ASSET ALLOCATION MODEL
If you read my article about the proper asset allocation of stocks and bonds by age, I've proposed five different types of asset allocation models. Each model instructs you to buy bonds based on a certain percentage of your overall portfolio.
1) Conventional Asset Allocation Model (Age = percentage allocation in bonds)
2) New Life Asset Allocation Model (A more aggressive blend than conventional)
3) Survival Asset Allocation Model (50/50)
4) Nothing To Lose Asset Allocation Model (100% equities until 65)
5) Financial Samurai Asset Allocation Model (hybrid between Nothing To Lose & New Life)
The Financial Samurai Asset Allocation Model shuns bonds until age 35, and begins with a 20% bond allocation until reaching a 50/50 split by age 75.
The Financial Samurai asset allocation model is based on the following assumptions:
- You have multiple income streams.
- You are a personal finance enthusiast who gets a kick out of reading finance literature and managing your money.
- You are not dependent on your 401k or IRA in retirement, but would like it to be there as a nice bonus.
- You are not dependent on Social Security.
- You are an early retiree or one who is shooting to be an early retiree who won’t be contributing as much to your pre-tax portfolios as before.
- Average genetics and plan to live between the ages of 80-90.
In other words, my model is relatively aggressive. What's interesting is that according to the data analysis of the ~165,000 mass affluent users of Empower's financial dashboard (most of whom are not paying clients, but free dashboard users), their bond allocation is also very minimal, much like the Financial Samurai Asset Allocation Model!
Let's explore the data in a little more detail.
BOND ALLOCATION BY AGE FOR THE MASS AFFLUENT
Study these six charts from Empower's demographics carefully. The easiest way to analyze the charts is to compare the age range with the bond allocation in red. The higher the difference, the higher the investment risk compared to conventional wisdom.
At the end of the asset allocation charts, I'll share with you five key takeaways.
Average bond allocation for 20-34-year-olds is 9%.
Average bond allocation for 35-44-year-olds is 10%.
Average bond allocation for 45-54-year-olds is 12%.
Average bond allocation for 55-64-year-olds is 16%.
Average bond allocation for 65-74-year-olds is 19%.
KEY TAKEAWAYS FROM THE BOND DATA BY AGE
If you want to buy bonds, review the following points.
1) Young people aren't taking the most risk, older people are.
Not even in my most aggressive “Nothing To Lose Asset Allocation Model” or “FS Asset Allocation Model,” where there's lots of alternative income streams, would I ever recommend a 65+ year old to only have 18-19% of their investment portfolio in bonds.
65+ year olds are likely no longer interested in working 40+ hours a week. I certainly don't know any 75-89 year olds who are working steady day jobs. A 20% or less bond + cash allocation for people under 44 seems more digestible, since people under 44 have at least 20 years to make up for any massive losses.
2) The data is showing that the mass affluent are generally bullish about the economy.
That, or they are extremely bearish about the bond market, which has been rising for 30+ years in a row. I get a sense that after five years of a bull market in stocks, investors are overly confident about their investing prowess and have forgotten what financial pain feels like. Investment bloggers with zero financial work experience or formal education have gained tremendous popularity.
Robo-advisors have raised a tremendous amount of new funding because they can do no wrong when stocks keep going up. Don't confuse brains with a bull market. As Warren Buffet said, “After all, you only find out who is swimming naked when the tide goes out.”
3) Even in a downturn, things aren't so bad.
Let's say there is a 50% correction in the stock market for a 75-89 year old who displays the exact same asset allocation profile above with a 62% allocation in stocks. With bonds and cash equaling 32%, his/her entire portfolio will probably only be down by ~30%.
Now let's say that the average net worth for 75-89 year olds is $800,000 based on dashboard data; the 75-89 year old still has $560,000 left over after a 30% decline.
Surely $560,000 is enough to last a 75-89 year old for the rest of his or her life since the median life expectancy is roughly 81-84. The chances of another financial crisis like 2008-2010 in our lifetimes is small.
However, 2022 and 2023 has turned out to be the worst years for bonds in history because of a surge in inflation and an aggressive Fed. But this means that buying treasury bonds now is more attractive given yields are much higher.
I don't think we'll regret buying Treasury bonds yielding 5%. In fact, with Treasury bond yields at the highest levels since 2007.
4) Alternative investing is a decent percentage of every asset allocation.
For every age range, alternative investing comprises 5-7% of an investor's total allocation. That's a pretty decent allocation given private wealth managers who manage $5 million+ often have 10% alternative investing allocations recommendations.
I was just at a JP Morgan Chase Private Wealth meeting doing some research. I think the alternative asset allocation is structurally lower than it could be due to access being still quite limited to the majority of Americans.
Personally, I love investing in private funds that have 5-10-year investment periods. It's nice NOT to always know what prices are doing so I can focus on more important things in life.
I've also invested over one million dollars in private real estate investments. Real estate is my favorite asset class to build wealth. I just don't like being a landlord, hence investing in private real estate is a great solution for passive returns.
5) Maybe the mass affluent are much more diversified than the average person.
The median household has a large majority of their net worth in their primary residence – a scary proposition when the housing market crashed. I don't recommend any household have more than 30% of their net worth in their primary residence.
The Empower data only reflects linked investable assets. Not everybody links all their assets like real estate, coin collection, etc like I do. In other words, the overall net worth pie is likely much bigger with different slices and slice sizes.
My investments in stocks makes up about 23% of my overall net worth, if I don't count my online business. If I count my online business, stocks would make up less than 20% of my net worth. I've got 45% of my net worth in real estate, and 10% of my net worth in risk-free investments like cash and Treasury bonds.
If the market takes a dump, I will still suffer on paper due to my real estate investments, but my cash flow will stay sticky because rents, CD interest income, dividend income, and online income are relatively sticky. It's ironically easier to generate more passive income in a bear market sometimes.
Furthermore, I strongly believe in my ability to hustle and make more money if necessary because I've made money from nothing before. Overconfidence in one's ability to make money may be the key reason why every single mass affluent demographic above is under allocated in bonds.
I'm sure I'm being overconfident right now with a little bit of Dunning-Kruger given my 27+-years of investing experience.
HOW DO I BUY BONDS?
Just like stocks, there are plenty of different types of bonds to buy. I personally just buy individual Treasury bonds and municipal bonds through my online brokerage. I also sometimes buy bond ETFs like MUB, the iShares National AMT-Free Muni Bond in my after tax brokerage account. But bond ETFs have no maturity date, so you have to just ride the ups and downs.
I view bonds, cash, and some commodities as defensive positions in a portfolio.
Below are some other popular bond ETFs.
- iShares iBoxx Investment Grade Corporate Bond symbol “LQD”
- 20+ Year Treasury Bond ETF symbol “TLT” (iShares)
- iShares iBoxx $ Investment Grade Corporate Bond Fund symbol “LQD”
- 7-10 Year Treasury Bond ETF symbol “IEF” (iShares)
- Core U.S. Aggregate Bond ETF symbol “AGG” (iShares)
- iBoxx $ High Yield Corporate Bond Fund symbol “HYG” (iShares)
- PIMCO 25+ Year Zero Coupon U.S. Treasury ETF symbol “ZROZ”
- SPDR Barclays Capital High Yield Bond ETF symbol “JNK”
- Vanguard Short-Term Bond ETF symbol “BSV”
- Vanguard Extended Duration Treasury ETF symbol “EDV”
Here's a tutorial on how to buy treasury bonds and other types of bonds. If you buy treasury bonds and hold to maturity, they are risk free. If you buy bond funds or bond ETFs, you face principal risk if you need to sell at an inopportune time.
Hence, if you want lower risk, you should buy individual treasury bonds and hold them to maturity. Below shows the various types of individual bonds with various maturities you can buy.
There's Always A Place For Bonds In Your Portfolio
From a top down point of view, I understand why investors are shunning bonds for equities. If you can earn a 2.5% or greater dividend yield in a decently valued company that also has the potential for capital appreciation, why buy a 2.5% bond that only pays you back the principal if held to maturity?
But bond investors aren't stupid, and the bond market isn't inefficient. Much of the interest rate expectations are already baked in to current bond prices and yields.
If you're over 45 and have been enjoying a fantastic equity run by being heavily overweight equities, I suggest rebalancing your portfolio to be more in-line with the New Life or Financial Samurai Asset Allocation model. Even if you have a Survival Asset Allocation Model of a 50/50 split, you'll still probably make a high single digit return if the bull market continues.
The Empower data is very telling about mass affluent investor sentiment given the 165,000 samples. As the company grows, there will be further insightful data points to share. The key is making an educated guess as to what all the data means. That's where you make or save a lot of money.
Best Bond Alternative: Real Estate
Before you buy bonds, you should consider buying real estate. Real estate is like a bond with its steady rental income. However, real estate also provides shelter and tends to inflate faster than the rate of inflation. With inflation picking up, inflation is one of the best hedges.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms.
I view real estate as a bond plus type of investment, where there is an income component plus greater potential principal upside.
Best Private Real Estate Investing Platforms
Fundrise: A way for all investors to diversify into real estate through private funds with just $10. Fundrise has been around since 2012 and manages over $3.3 billion for 400,000+ investors.
The real estate platform invests primarily in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields are higher. The spreading out of America is a long-term demographic trend. For most people, investing in a diversified fund is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities also have higher growth potential due to job growth and demographic trends.
If you are a real estate enthusiast with more time, you can build your own diversified real estate portfolio with CrowdStreet. However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital.
I've invested $954,000 in real estate crowdfunding so far. My goal is to diversify my expensive SF real estate holdings and earn more 100% passive income. I plan to continue dollar-cost investing into private real estate for the next decade.
Invest In Private Growth Companies
In addition, consider investing in private growth companies through a fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
One of the most interesting funds I'm allocating new capital toward is the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Manage Your Finances In One Place
The best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Empower. They are a free wealth management tool which aggregates all your financial accounts in one place so you can see where you can optimize.
The best tool is their Portfolio Fee Analyzer which runs your investment portfolio through its software to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was paying!
Empower also launched the best Retirement Planning Calculator around, using your real data to run thousands of algorithms to see what your probability is for retirement success.
Once you register, simply click the Advisor Tolls and Investing tab on the top right and then click Retirement Planner. There's no better free tool online to help you track your net worth, minimize investment expenses, and manage your wealth. Why gamble with your future?
About the Author
Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $300,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
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