Investing involves the exchange of risk and reward. As investors we accept the risk that our portfolio will fluctuate in value over the short-term to earn the reward of returns over the long-term. The more volatile a particular investment over the short-term the higher the returns should be over the long-term. There are many factors that will influence returns such as valuation levels but at a high-level the theory of investing is straightforward.

Historically shares have had more short-term volatility and higher long-term returns. Historically bonds have had less short-term volatility and lower long-term returns. Cash has no volatility and the lowest long-term returns.

The million-dollar question is why a long-term investor would invest in anything but shares. And this isn’t an academic exercise. I get asked this question all the time. And many investors are taking this route. Even people who may not meet the definition of a long-term investors. The Wall Street Journal recently explored this topic in an article title Boomers Got Hooked on Stocks. Now They Can’t Let Go.

I’ve read a lot of articles about diversification. It is a bit like going to the dentist. I acknowledge the importance of flossing. I sincerely promise that I will floss more. I even take a free sample of floss. It gets added to the other free samples which somebody will have to collect from my apartment after I’m dead. And if the cause of death is not flossing enough - I guess the joke is on me.

I could write an article on why it is a terrible idea to just invest in shares. It would be boring. For people that invest in bonds it would be validating. And they would enjoy the article because we all like to read things that validate what we already believe. People who only invest in shares could read my article and add bond investing to the special to-do list we all keep for things we know we will never do. Perhaps right after flossing more.

I’m not going to write that article on the merits of bonds. It would be hypocritical. I don’t actually own any bonds. I own growth assets and I have cash. That is it. My approach is not for everybody. But successful investing is about understanding different strategies. And why they work given one set of circumstances and poorly given another. That is the purpose of this article.

Part one of this article will cover investors who have a long-term orientation and part two will address investors transitioning to retirement and retirees.

Checklist for an all-equity portfolio

  1. Have the right temperament to hold for the long-term and resist over trading
  2. Understand the implications of the decision and get your financial house in order
  3. Widely diversify
  4. Consider a focus on income
  5. Using cash to mitigate risk during and after the transition to retirement


Shares vs bonds: Returns and volatility

According to Vanguard, Australian shares have returned 9.2% per annum over the last 30 years while Australian bonds have returned 5.5% over the same period. If $1000 a month was invested in shares starting 30 years ago the 100% share portfolio would be worth close to $1.8m. The 100% bond portfolio would have just under $900k.

Long-term share investors did get the reward of higher returns. The question is what they gave up for that reward. A common measure of volatility is standard deviation. And we are going to briefly get technical, but I promise it is the understanding the concept and not the detail that matters.

The standard deviation measures the dispersion of returns around the average return. And standard deviation assumes that returns are normally distributed. There are a lot of indications this is not the case but bear with me. With normally distributed returns a standard deviation of 5 and an average return of 7% allows us to make the statement that 95% of the time this portfolio will have an annual return between -3% and 17%. That is because with normally distributed returns 95% of the time they will be between 2 standard deviations of the average return.

Over the past 10 years the ASX 200 has a standard deviation of around 14. This compares to a standard deviation of 4.15 for the Bloomberg AusBond Core Composite Index. Shares are more volatile than bonds. It would not be inaccurate to say they are much more volatile than bonds. Investors are taking on a lot of short-term volatility to get higher long-term returns.

Does volatility matter?

My colleague Shani has written on this topic before. The summary is that in theory short-term volatility doesn’t matter if an investor has a long-term goal. If I need a certain amount of money 30 years from now, it doesn’t really matter what the value of my portfolio is on September 22nd 2026. The value of my portfolio won’t matter the next day or the day after that. You get the point. All that matters is that I have enough money the day I need it. For most investors that singular day will never come as they will only sell off a portion of their portfolio to pay for retirement each year.

That is the theory. But to paraphrase Mike Tyson, everyone has a plan until they get hit in the face. The theory goes out the window if the volatility of shares causes an investor to do something dumb. The dumbest thing an investor can do is sell shares once they have dropped in value significantly, sit out the rally and buy when shares have already gone up in value. That is selling low and buying high.

Investors with 100% of their portfolio allocated to shares must be confident – very confident – that they won’t do something dumb. Selling at the bottom of a major market drop and missing a rally can wipe out the higher returns shares have provided over the long-run. An investor who missed the 10 best days in the US share market over the last 30 years would have cut returns in half. Missing the 30 best days would have reduced returns by a staggering 83%.

I know that the success of my approach is predicated on not selling shares during a market drop. I am not glib about my proclamation that I will not sell. I know what it is like to hold on during a brutal bear market. The press is full of stories of economic disasters and predictions for even bigger disasters. Many other people are selling and hour by hour and day by day each drop grates on even the most steadfast investor. I lived through the GFC. I didn’t sell but it wasn’t easy.

Investors tend to be a confident group of people. I am sure that many readers are picturing the impossibility of deciding one day to sell everything and go 100% to cash. Fair enough. The issue is that volatility causes other issues. As humans we are conditioned to go into fight or flight mode in response to challenges. Volatility is a challenge. Flight is going 100% to cash. Fight is finding better investments.

The combination of overconfidence and volatility means more trading. That is why the average investor underperforms the investments that they purchase by 1.7% a year. That is massive and a result of poor timing decisions which mainly comes from chasing performance. Too much trading as a result of overconfidence is also why male investors underperform female investors.


One reason often cited for building a portfolio with both shares and bonds is diversification. There is a lot of confusion about diversification despite the simple analogy of not having all your eggs in one basket. In my mind diversification is about lowering the risk from your portfolio.

An investor purchases more than one company to lower security specific risk from a portfolio. Purchasing international shares lowers the risk that the Australian share market is adversely impacted by local economic conditions. Having a mix of sectors in a portfolio lowers sector specific risks. You get the point.

The question is what risk does purchasing a bond lower. Adding a bond to a portfolio lowers the volatility of the overall portfolio. And volatility is a real risk for investors that are currently or will shortly sell off assets in their portfolio.

For many investors with long-time horizons this is not a risk if the volatility doesn’t cause poor decision making. For investors that do face the risk of volatility there are other ways to lower it by holding less volatile shares, holding cash and focusing on income. That is the approach I’ve taken with my mother’s portfolio in her retirement.

There is another reason that many people cite as the reason to diversify a portfolio using bonds. That when shares prices rise, bond prices fall. And more importantly when share prices fall, bond prices rise.

I remember this was one of the first things somebody told me about investing. It is a nice example of unexamined conventional wisdom that we overly rely on when making decisions. On the surface it seems like it is true. And if you don’t think about it too much it seems like a good thing.

There are two problems with this notion. The first is that it isn’t true. Share and bond prices move in the same direction all the time. Interest rates going up isn’t great for shares and makes bond prices fall. Inflation is bad for shares and bonds. I could go on.

The other problem is more important. If share and bond prices actually moved in opposite directions, would it be good to include them both in a portfolio. This is the notion of uncorrelated assets. And there are some professional investors who get really excited about uncorrelated assets. I’m less excited about them.

An uncorrelated asset is something that will move the opposite way as the rest of a portfolio. A perfectly uncorrelated asset would match the move of the other asset in the opposite direction. Asset A goes up 10% and asset B falls 10%.

There are reasons to include uncorrelated assets in a portfolio. The first reason is that it lowers the volatility of the overall portfolio and for some investors that is a goal. A related second reason is that holding uncorrelated assets could limit the size of the possible drawdown in a portfolio. The other reason is if you are tactically preparing for poor market conditions.

Once again limiting volatility and the size of a drawdown can be strategies that work for specific investors who are approaching a goal. The case is less obvious for long-term investors who have decades before their goals for the same reasons previously discussed. Tactically adjusting your portfolio for perceived market conditions can be very dangerous. Most investors won’t get that call right or won’t get the timing of the call right. This constant desire to tactically adjusting a portfolio leads to overtrading. That is why investors underperform investments. That is why after-tax returns can be so poor and investors pay so much in transaction costs.

The focus on uncorrelated assets may be a case of individual investors following professional investors when their goals are not aligned. Professional investors have incentives to try and adjust portfolios tactically to consensus views of market conditions. Career risk causes professional investors to follow the John Maynard Keynes maxim that is better for a reputation to fail conventionally than to succeed unconventionally.

Going out on a limb professionally is a risky career move given that short-term underperformance can have an adverse impact on the success of a professionally managed fund which may cause those professionals to lose their high paying jobs. Individual investors have less of a structural impediment to truly focus on the long-term. An advantage that should not be easily given up.

Should you invest in only shares?

Maybe. If this is the decision you are making you better have the right temperament. Resisting the temptation to bail out during an extended bear market or constantly adjusting your portfolio is a very difficult thing to do. It should not be underestimated.

Investors should diversify widely across equity markets. This means on an individual holding basis but also across different markets, different sectors and different styles of investing. One easy way to do this is by simply holding the entire market through broadly diversified passive indexes.

Investors should also get their financial house in order to ensure that they don’t have debt and have a sufficient emergency fund. However, as I argued in my series on gaining financial independence investors with a longer time horizon may want to keep an emergency fund at the bare minimum to take advantage of the higher returns offered by shares over the long-run. The emergency fund can be built up later in life when the opportunity cost of cash is lower.

Investors should understand that the volatility of different types of shares will be different. As will the risk of permanently losing money. Some companies have more business risk than others. Consider a focus on large quality companies with sustainable competitive advantages that are in a strong financial position and pay dividends in mature industries. That can blunt volatility and lowers the risk they will go out of business.

Finally, valuation matters. Buying the exact same company trading at 40 times earnings instead of 20 times earnings is riskier. Lower valuations mean lower risk. A disciplined approach that puts valuation levels at the forefront of investing decisions is critical.


I’ve personally taken an income approach as I believe it helps to ensure I maintain the right temperament and keep a the long-term, focus on what matters and gravitate to the right kinds of shares. I’ve described that approach in this article.

The biggest risk for any investor is not understanding the implications of investment decisions. If an investor decides to build a portfolio that is only made up of shares it is not a decision to be made lightly.  This strategy can work but only if the investor understands those risks and is mentally and financially prepared to truly focus on the long-term.

Do you have a portfolio heavily weighted to shares? Let me know how you deal with the behavioural risk associated with volatility at