I recently read a good tip from one of the best value investors alive today. Chris Browne has an extraordinary record for delivering returns to investors and in his book “The Little Book of Value Investing” he not only gives a good overview of just what’s involved in getting started as a value investor, he also gives some great advice about allocating a portfolio.

The ordinary advice I hear is to base your allocation between bonds or fixed income instruments and stocks using a formula based on your age. 120 - (your age) = percentage that should be in stocks, the rest should be in fixed income. Chris Browne makes a good argument against that. While there is a good reason to have a portion of your portfolio in bonds that portion should never exceed 3 years worth of income.

Here’s why:

As a stock investor the worst thing to do is to sell when the market is down. In most rolling 3 year periods throughout history the return from bonds is lower than that from stocks. If you needed to access the money in your portfolio during a down turn in the market it would make more sense to liquidate the bonds rather than sell the stocks at a depressed price.

Over longer periods a stock portfolio returns significantly better returns and is better tied to inflation than bonds are. Why give up on those better returns?

Take Home Advice:

1. Keep a relatively small portion of your portfolio in bonds. (maximum of 3 years income)
2. Any long term investments should be in stocks for the higher returns
3. If the market is down take money from the bonds, if it’s up take money from the stocks.