# Stocks vs bonds: risk capacity, tolerance and the job you have

> How different stock and bond mixes behaved, and how horizon, income and nerves decide the mix.

- Course: [Long-Term Investing: Index Funds, Risk and Your Own Behavior](https://productovi.com/courses/long-term-investing.md)
- Module: Building the model portfolios
- Lesson 22/32, ~20 min
- Source: https://productovi.com/courses/long-term-investing/stocks-bonds-mix

## Six mixes, forty years

**Alex Tutor:** Still July at Zapas. Bonds are no longer the "safe" part, so today you and Grace decide how much of each portfolio goes into stocks and how much into bonds.

**Grace:** I ran six mixes through the forty synthetic Tessaro years, from all bonds, 0/100, to all stocks, 100/0. Bonds here are half short, half long, and every mix goes back to its target each year-end.

**Grace:** All numbers are real, after inflation. For each mix: the yearly return, the worst year, the largest fall from a peak and what \$1,000 became after forty years.

**Dataset (CSV):** [Model mixes over 40 synthetic years, real terms](https://productovi.com/datasets/long-term-investing/stocks-bonds-mix/portfolios.csv)

Stocks = Tessaro World; bonds = half Tessaro Short Bonds, half Tessaro Long Bonds; rebalanced every year-end. avg/geo = arithmetic/geometric real return a year; worst_real_year_pct and worst_year; max_drawdown_real_pct from peak year to trough year; years_underwater = from the peak until back above it (not_by_40 = still below at the end of year 40); real_value_of_1000 after 40 years. Synthetic data.

**Real return vs worst year and largest fall, by mix**

| Stocks/bonds, % | Return a year | Worst year | Largest fall |
| --- | --- | --- | --- |
| 0/100, all bonds | 1.7 | -12.7 | -22.8 |
| 20/80 | 2.7 | -15.1 | -25.2 |
| 40/60 | 3.6 | -17.6 | -27.6 |
| 60/40 | 4.4 | -20 | -30 |
| 80/20 | 5.2 | -24.3 | -38 |
| 100/0, all stocks | 5.9 | -31.8 | -48.2 |

*60/40 means 60% stocks, 40% bonds. Geometric real return a year, worst real year and maximum real drawdown, synthetic Tessaro years 1–40.*

**Ethan:** Easy. 100/0 ended highest. Why would anyone pick less?

**Grace:** Because the user has to live through the path, not just the end. Start with the end anyway: how far ahead is 100/0 of 60/40?

> **Exercise:** In the synthetic Tessaro history, \$1,000 in the 100/0 mix grew to \$9,875 in real terms over 40 years, and \$1,000 in the 60/40 mix to \$5,700. How many dollars more did 100/0 end with?

**Sofia:** Almost twice the money. But the worst year goes from −20.0% to −31.8%.

**Grace:** And the largest fall from −30.0% to −48.2%. On a \$10,000 balance that's the difference between seeing \$7,000 and seeing about \$5,200. The second number is where many people sell.

**Sofia:** And the falls grow fast. Do bonds always cut them in proportion?

**Grace:** Roughly, yes. Match the mixes to their largest real fall.

> **Exercise:** Match each stocks/bonds mix to its largest real fall from a peak (maximum drawdown) in the synthetic Tessaro history.

**Sofia:** So up to 60/40 the falls stay around a quarter to a third, and then they jump.

**Grace:** Right, because the stock crash of years 21–22 takes over. Below that, the bond year 36 sets the worst year.

**Ethan:** Then the all-bond mix is the one for nervous users. Lowest falls, done.

**Grace:** Look at the last columns. 0/100 and 20/80 peaked in year 34, fell through the inflation years and were still below that peak at the end of year 40.

> **Exercise:** In the synthetic Tessaro data, the all-bond mix (0/100) was the lowest-risk choice in every respect: its falls were small and it always recovered quickly.

**Sofia:** So how do we decide who gets which mix? Asking "how brave are you?" feels thin.

**Grace:** It is thin. There are two different things. **Risk capacity**: can the plan survive a fall? That's horizon, income and a cushion. **Risk tolerance**: will the person actually hold through it?

![Risk capacity (horizon, income, cushion) and risk tolerance (what you would do at −30%) each set a limit on stocks; the mix follows the lower one.](https://productovi.com/courses/long-term-investing/diagrams/m6-l2-two-limits.png)

*Both limits are measured, neither is read off the user's age.*

**Grace:** Take you and Ethan. You're salaried with a cushion. A founder's income can stop for months, so the same 25-year horizon carries less capacity.

**Ethan:** Hey. Fair, though. My nerves are fine; my salary isn't.

> **Exercise:** Two Zapas users save for the same goal 25 years away and both say they are calm in a fall. Who has the higher risk capacity?

> **Exercise:** Zapas drafts onboarding questions. Which of them measure risk **capacity** rather than tolerance? Select all that apply.

**Ethan:** Fine. But I still want young users to get 100/0 by default. They have forty years.

**Grace:** Forty years is a horizon, and a horizon is only one part of capacity. Look at income and cushion: an under-30 user on short contracts with no savings may have to sell in a bad year just to pay rent, and age doesn't tell you that. Tolerance we take from their answer to the −30% question, not from their birth year.

> **Exercise:** Ethan wants every user under 30 placed in 100/0 by default "because they have forty years". In 2–3 sentences, explain what this ignores, using the risk numbers of the mixes and the difference between risk capacity and risk tolerance.

**Grace:** Good. Next question: users don't arrive with a portfolio, they arrive with money. Do we invest it at once or monthly, and how do we keep each mix on target?

> **Key ideas**
>
> - More stocks: a higher end and a rougher path. In real terms 0/100 made 1.7% a year with a largest fall of −22.8%; 100/0 made 5.9% with −48.2% and 11 years under water.
> - Describe each mix by return, worst year, largest fall and time under water.
> - Low swings are not low risk: 0/100 and 20/80 hadn't regained their year-34 peak by year 40.
> - Risk capacity (horizon, income, cushion) and risk tolerance (reactions) each limit stocks; use the lower one.
> - Rules of thumb like "a bond share that grows with age" are trade-offs, not rules.

> **Educational, not advice**
>
> This lesson explains how investing works; it doesn't tell you what to buy. Investments can fall and you can get back less than you put in. Check the current rules where you live or ask a licensed professional.

- Previous lesson: [Bonds: yield, rate risk and the year both fell](https://productovi.com/courses/long-term-investing/bonds-rate-risk.md)
- Next lesson: [Regular amounts, a lump sum and rebalancing rules](https://productovi.com/courses/long-term-investing/contributions-rebalancing.md)

---
Productovi Learning. Free, no sign-up needed to read.