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How to Invest in Stock and Bonds

It's been said that investing is simple but not easy. In other words, the underlying principles are straightforward, but it can be hard to stick to them, especially in times of market upheaval. One thing that makes it easier to stick to the plan is to actually have a plan.

Today, I want to spend a little time laying out a simple investing strategy to help you formulate a plan of your own. Of course, there is no one-size-fits-all solution, but what follows is a good jumping off point.

For the purposes of this post, I'm going to assume that you're comfortable with a passive investing strategy, and I'm going to use Vanguard mutual funds as my vehicle of choice.

For starters, you'll need to decide on your stock/bond mix. As a rule of thumb, I recommend starting with holding your "age in bonds" and adjusting from there based on your risk tolerance and capacity. For a 40 year old, this would work out to a 60/40 stock bond mix +/- whatever it takes to make you comfortable.

When it comes to having multiple accounts, it's important to view the overall portfolio as one big bucket of money. You don't need to have the target allocation in each and every account, just overall. Thus, you can (and should) think about tax efficiency when placing your investments.

In other words, tax inefficient investments (such as bonds) should go in tax advantaged space and tax efficient holdings should be placed in taxable space (assuming you don't have enough tax advantaged space to hold everything).

That's it. Once everything is set up, it's just a matter of maintaining it. For dividends, I personally prefer to have everything in our taxable account paid into a money market. I then reinvest quarterly into whichever portion of our portfolio is low relative to our target allocation. This helps to minimize the need for re-balancing.

Speaking of re-balancing, you should do this according to set criteria. Either annually (or on some other periodic schedule) or whenever your investments get more then a certain percent out of whack. For example, if you are targeting 60:40 stocks and bonds, then re-balance when your stock allocation gets above 66% or below 54% (this would be a 10% re-balancing band).

Over time, you'll of course want to adjust your allocation. As you approach the time when you'll need the money, you should generally be moving toward a more conservative allocation. The "age in bonds" rule does this automatically. You don't need to tweak it each and every year, but you should be generally moving in the direction of a more conservative portfolio.

*Note: To be fair, target date mutual funds are even simpler than what I've outlined above. Unfortunately, if you just pick by year, you may end up with a more aggressive allocation than you bargained for (e.g., the Vanguard TR 2035 fund currently has 88% in stocks), you lose control over the "glide path" (i.e., the rate at which it becomes more conservative), and you also lose the ability to maximize tax efficiency.