EP 236: How to Choose Your Stock/Bond Mix (and Stick With It When Markets Get Ugly)

by Peter Lazaroff | Dec 24, 2025 | Podcast

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This is the fourth episode in a short series about portfolio construction, with each episode building on each other. If you missed the first three, here they are:

EP 235 ended by saying we’d continue the conversation with how you actually implement this stuff. That’s what we’re doing today, starting with the biggest decision in your portfolio: your mix of stocks and bonds.

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The Real Definition of Risk

Before we talk about choosing an asset allocation, we need to get clear on one thing—because most bad allocation decisions start with a bad definition of risk.

There are lots of different types of risk. Most people talking about investments will use volatility as the definition of risk, which isn’t necessarily wrong for true capital allocators. But for investors like you, the one I want to focus on is the risk of failing to fund your life.

Your portfolio going down in value is just something that’s going to happen. We never know when or why the next downturn will occur, but we can build a portfolio that assumes we will experience downturns of a similar magnitude and frequency as we have in the past.

That’s why I think the more important risk for us to focus on is failing to fund your life. And “funding your life” isn’t just about not running out of money—it’s about having enough to use it in ways you won’t regret later.

And once you define risk that way, you can finally see the stock-and-bond decision for what it is: not a moral choice, not a temperament test, and definitely not a search for “safety.”

It’s a tradeoff.

Stocks carry the risk you can feel: big swings, scary headlines, drawdowns that test your nerve.

But stocks also give you the thing long-term investors actually need: the best shot at compounding your purchasing power over decades.

Bonds reduce that visible volatility. They steady the ride.

But bonds don’t eliminate risk—they change the kind of risk you’re taking.

When you own more bonds, you’re often trading away the risk of a scary statement for the risk of a quietly underfunded future. You’re paying for comfort with lower expected long-term growth. And that can show up later as one of three outcomes: you save more, work longer, or spend less than you hoped.

So here’s my starting point:

If you’re a long-term investor and you can tolerate it, equities should be the default growth engine. Not because stocks are “safe”—they’re not—but because the long-term risk of not owning enough stocks is often bigger than people admit.

At the same time, I’m not here to shame bonds. Bonds have a job. For a lot of people, bonds are what keep them invested in stocks when markets get ugly. And that behavior—the ability to stick with the plan—matters more than finding the mathematically optimal mix.

In the rest of this episode, we’ll do two things:

Decide the right mix of stocks and bonds—based on your ability to take risk and your willingness to live with it.
Talk about implementation: how to fill the stock sleeve, how to think about bonds, where cash fits, and how to rebalance without making it up as you go.

Let’s start with the foundation.

Choosing the Right Mix of Stocks and Bonds

Asset allocation is simply the decision of how you divide your portfolio—primarily between stocks and bonds—to balance risk and return for your situation. And decades of evidence point to the same conclusion: this decision explains most of the year-to-year experience you’re going to have.

So the goal here isn’t to find the one “correct” allocation. The goal is to find the mix that fits you—so you can stay invested, through full market cycles, without improvising at the worst possible time and fund the life you want to live.

For that, I use a two-part test:

Your ability to take risk, and
Your willingness to live with it.

And the right allocation is basically the overlap between those two.

Ability to Take Risk (Objective Capacity)

Ability is about the math and the structure of your life. It’s not a personality test.

Here are the factors that matter most:

1) Time horizon

When will you first need the money, and over what window will you spend it?

The longer the runway, the more short-term volatility you can tolerate because you’re giving compounding time to work. Short runway? Less capacity.

If part of the portfolio is intended for children, philanthropy, or a long legacy timeline, that sleeve can be invested with a longer horizon—and that changes the conversation.

2) Liquidity needs relative to portfolio size

This is really a ratio: how big are your near-term needs relative to your assets?

If your likely spending needs from the portfolio are small relative to your portfolio’s size, you have more capacity for risk. If those needs are large relative to assets, capacity drops.

This is where the previous episode on cash management fits perfectly: a real cash system reduces the chance of forced selling, which increases your ability to maintain a growth allocation.

3) Human capital

Human capital is earning capacity.

If you’re younger, still earning, and your income is stable, you can replace market losses with future savings. That increases your capacity.

If you’re retired, or close to retired, or your income is cyclical or uncertain, your human capital is lower—and your capacity is lower.

Some retirees have strong “human capital substitutes”—pensions, annuity income, rental income—cash flows that act like a stabilizer. That raises capacity compared to someone living solely on portfolio withdrawals and Social Security.

4) Safety nets

This is the part we covered most in the last episode. The bigger your safety net—cash reserves, insurance, and reliable income—the less likely you are to become a forced seller when markets drop. And the less likely you are to become a forced seller, the more equity risk you’re able to carry in the long-term portfolio.

5) Flexibility of your goals

If you can adjust spending, delay retirement, pick up income, or reduce certain goals temporarily, you have more capacity to hold a growth allocation.

If spending is rigid—fixed bills, little room to cut—capacity drops.

When you step back, ability is really one question:

Do you have enough time, flexibility, and a safety net to let equities do what equities do—without forcing you into a bad decision?

If the answer is yes, your capacity is higher. If the answer is no, your capacity is lower.

Willingness to Take Risk (Subjective Capacity)

Willingness is the psychological side. It’s somewhat tricky to measure.

Risk tolerance questionnaires are notoriously flawed. And your own judgment about your willingness to tolerate (not just take) risk is likely to be biased as well.

So instead of pretending there’s a perfect questionnaire, here’s the simplest test I know.

I refer to it as “the dollar drawdown test,” and we treat it as a final gut-check before committing to an allocation.

Basically, if you look at the worst 1-year, 3-year, and 5-year market returns and translate those losses to your portfolio in dollar terms, would you be okay sticking with the predetermined asset allocation and rebalancing plan?

For example, if you have a $1 million portfolio and we see that the worst 12-month period for a given allocation was down 40%, we will ask: How would you feel if you lost $400,000?

That kind of drawdown has happened before. The exact number will vary based on your mix, but the point is the same.

It’s a good litmus test. Because in the worst situations, the “optimal” allocation on paper is irrelevant if you’re unable to hold on to it and rebalance into it when it’s uncomfortable.

Choosing How to Fill Your Stock and Bond Allocations

Now that we can assume your stock/bond mix is set, the next step is choosing what goes in each sleeve.

One clarification before we move on: Cash belongs on your household balance sheet for near-term needs and reserves. Inside the investment portfolio, cash is typically kept small because, over long spans, cash has historically struggled to beat inflation after taxes.

Your portfolio is for compounding. Cash is for stability and near-term liquidity. Don’t confuse the two.

When we think about how to fill the stock bucket, start with a global mix. Research suggests that the diversification benefit from investing beyond the US kicks in somewhere between a 20–50% allocation to non-US stocks. We have a 30% allocation here at Plancorp. Some people believe in having the allocation drift alongside market weights.

When it comes to equity strategies, I touched on two rules-based (my preferred term for what I think a lot of people think of as “passive”) approaches in EP.234: Index vs. Factor Investing.

When it comes to bonds, I’m firmly in the bond fund camp. For most long-term investors, bond funds are the simpler and more reliable tool. The cases where individual bonds make sense are narrower than people assume.

And when it comes to bond funds, I’m much more hesitant to use index funds. The bond market is structurally so much different than the stock market—perhaps the most notable difference being that over half of bond purchasers don’t have a return maximization objective.

See EP.99: The Problem With Investing in Bond Indexes

Rebalancing

I haven’t done an episode on rebalancing in a long time. And since I just referenced an episode that is about 20 months old, I’ll spend a few minutes here to close out.

Rebalancing brings your portfolio back to the mix of stocks and bonds you intended. There are some periods where it can enhance return, but I think it’s better to set your expectation around it being a risk management tool.

I’ve looked hard for the “perfect” rebalancing strategy over the years. The simple answer is: there isn’t one.

What works best depends on the period you measure. We can’t know what will work best without perfect foresight.

To me, that means the most important thing you can do is pick a system and stick with it forever. The two most practical ways are via calendar rebalancing and threshold rebalancing.

Calendar rebalancing: pick a fixed date—often quarterly or annually—and reset the portfolio to target weights.
Threshold rebalancing: define tolerance bands (for example, ±5 percentage points around each major sleeve), and rebalance only when drift is meaningful.

One practical tip: use cash flows first. If you’re contributing, direct new money to what’s underweight. If you’re withdrawing, pull from what’s overweight. Do that before you start selling holdings.

The evidence doesn’t produce a single winner across all periods or portfolios. Our research suggests using threshold rebalancing is best if you’re able to check your portfolios. So we obviously do that at Plancorp, but I realize that individual investors and even smaller financial advisory firms can’t logistically do that. In those cases, choosing a rule you will relentlessly adhere to is the next best option.

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