TENETS STAND TEST OF TIME

The more things change, the more they stay the same. The past decade has thrown a lot of challenges at investors — the subprime mortgage crisis, a steep recession, a slow recovery, near-zero interest rates, wars, terrorism and more. But against this backd

STOCKS WIN OVER TIME

Ibbotson, which costs $185 and now is published by Morningstar, tracks investment returns back to the start of 1926 for asset categories including stocks, bonds and cash (Treasury bills). The results show that stocks outperform everything else, given enough time.

A hypothetical $1 invested in Treasury bills in the mid-1920s would have grown to more than $20 by the end of 2014, assuming all yields were reinvested and ignoring taxes. That equals a compounded average annual growth rate of 3.5%, which would have kept T-bill buyers just slightly ahead of the 2.9% annual inflation average over the 89-year period.

Bonds would have done better, with $1 staked into long-term government bonds rising to $135, or 5.7% annually on average. But $1 invested in a portfolio of large U.S. stocks, such as those in the Standard & Poor’s 500 index, would have swelled to $5,317 by the end of 2014, representing annual growth of 10.1%. The same $1 placed in riskier small-company stocks would have mushroomed to $27,419, a 12.2% yearly pace. Clearly, high risk and high return go hand in hand.

These figures include price gains and reinvested interest or dividend income.

BUT THEY DON’T DO SO CONSISTENTLY.

Stocks represent ownership in companies that form the backbone of the economy. As the economy grows, corporate values do, too. But the price to be paid for investing in the stock market is an acceptance of risk — sometimes big dollops of it.

Investors lose money almost three calendar years each decade on average. Large stocks have posted average returns of 10.1% a year, but they seldom deliver that in any particular year: Since the mid-1920s, there have been only five calendar years — 1926, 1959, 1968, 1993 and 2004 — when stocks returned 9%, 10% or 11%.

That’s why it’s essential to take a long-term viewpoint. Large stocks gained ground in 65 of the 89 calendar years over Ibbotson’s measuring period, or 73% of the time. But they finished with positive returns in 86% of the rolling five-year periods and 95% of the 10-year intervals. And if you hung on for 20 years, you never would have lost money in a diversified basket of stocks.

Even if you had the incredibly poor luck of investing in the weakest rolling 20-year stretch of all, 1929 through 1948, the 3.1% average annual return for stocks over that time would have nearly matched the overall returns generated by T-bills.

“The effects of time diversification are clearly evident,” Ibbotson says. .

ADDING BONDS AND CASH CAN HELP.

It also pays to add bonds and cash instruments such as T-bills to dampen the risks of a stock-market portfolio. Think of these as an anchor. They will slow your boat during balmy weather but keep it from crashing into the rocks during a storm.

In fact, incorporating these other diversification building blocks into a stock-based portfolio doesn’t mean you must sacrifice all that much return.

For example, a portfolio split 50-50 between stocks and bonds, carrying little more than half the risk of a pure-equity mix, would have returned a solid 8.4% annually since the mid-1920s, according to Ibbotson. A 70-30 stock/ bond allocation, while onethird less risky than all stocks, would have delivered 9.2% a year on average.

REBALANCING KEEPS YOU ON TRACK.

Once you devise an overall asset allocation, it’s smart to rebalance the mix every now and then. How often? There’s no set answer. You might decide to rebalance once a year or after you stray by a certain percentage from your target.

Rebalancing forces you to take some chips from your hot assets and reinvest the proceeds in laggards. It’s a buy-low, sell-high approach that helps remove emotions from the equation.

Rebalancing also makes sense because stocks, like weeds in a garden, will take over if left untended for too long. “Because stocks have outperformed bonds over the long run, it only makes sense that the proportion (in a portfolio) allocated to stocks will inevitably grow over time as well,” Ibbotson notes. As an extreme example, a portfolio split 50-50 between stocks and bonds in 1926 would have morphed into one with nearly 98% in stocks and just 2% in bonds by the end of 2014.

In other words, portfolios that aren’t rebalanced will grow riskier over time — just as most investors are becoming more conservative as they age.