For a defensive investor, how should asset allocation between bonds and stocks be balanced?

Okay, friend, let's talk about this topic. A defensive investor, in simple terms, is someone who prioritizes "don't lose money" and seeks "safe returns." The founding father of this approach is Benjamin Graham, Warren Buffett's teacher. The strategies in his book "The Intelligent Investor" are still highly relevant today.

Below, using plain language and Graham's philosophy, I'll break down how to balance between stocks and bonds.

Core Principle: The 50/50 Baseline

Imagine your investment portfolio as a seesaw. One side is stocks, the other is bonds.

• Stocks: High potential for making you rich, but also highly volatile, like an energetic yet somewhat mischievous child. They make you smile when the market is good but keep you awake at night when it's bad.
• Bonds: Steady, offering modest but reliable returns, like a steadfast, reliable adult. Their main job is to provide stable interest income and protect your principal when the stock market falls.

For the defensive investor, the most core and simplest advice Graham gives is: Split your funds in half, putting 50% into stocks and 50% into bonds.

This 50/50 split is your "default setting" or "baseline." Why?

1. Offense and Defense: One half (stocks) is for offense, capturing the benefits of economic growth and combating inflation. The other half (bonds) is for defense, providing stable cash flow and reducing the overall risk of the portfolio.
2. Simple Discipline: This ratio is incredibly simple, saving you from constantly guessing market movements. It provides a disciplined framework, preventing you from making poor decisions based on fleeting greed or fear.

Dynamic Adjustment: The 25/75 Pendulum Strategy

Of course, Graham wasn't inflexible. He said the 50/50 is the baseline, but you can make small tweaks within a fixed range. This range is:

No matter how the market changes, your stock allocation should never fall below 25% and never exceed 75%.

Think of it like putting safety bumpers on both ends of your seesaw, preventing either side from going too high or too low.

So the question is, when should you buy more stocks, and when should you buy more bonds?

Graham's logic is simple: Be counterintuitive / Contrary.

• When the stock market becomes very expensive (market exuberance): You should feel wary, not excited. At this time, gradually sell some stocks and buy bonds, moving your stock allocation toward 25%. This is called "taking profits," locking in gains from frothy times into the safety of bonds.
• When the stock market becomes very cheap (market panic, e.g., a crash): You should feel greedy, not fearful. At this time, use the funds from your bond allocation to gradually buy cheap stocks, moving your stock allocation toward 75%. This is called "bargain hunting," using the money from your safety cushion to buy at the bottom.

This strategy acts like an auto-pilot system, forcing you to pull back when others are greedy and step in when others are fearful.

How to Judge if the Market is "Expensive" or "Cheap"?

This might be the hardest step. For ordinary investors, you don't need to be a valuation expert; you can refer to some simple indicators:

• Look at the overall market Price-to-Earnings Ratio (P/E Ratio): For example, look at the overall P/E of the CSI 300 index or the S&P 500 index and compare it to its historical average over the past 10 or 20 years. If it's significantly higher, the market might be expensive; if it's significantly lower, it could be cheap.
• Gauge market sentiment: When relatives and friends who never trade stocks start talking about them, and everyone seems to be a stock wizard, the market is probably overheated. When the news is full of doom and gloom, and people avoid stocks like the plague, opportunities may arise.

Concrete Advice for Defensive Investors

1. How to choose stocks?

   • Prioritize Index Funds: For the vast majority of defensive investors, picking individual stocks is time-consuming, labor-intensive, and risky. Directly buying broad-based index funds like CSI 300 ETFs or S&P 500 ETFs (e.g., VOO, SPY) is often the best choice. You're not buying a single company, but the average of the entire market – sufficiently diversified and worry-free.
   • If you want to pick individual stocks, you must still follow Graham's principles: choose large, financially sound, consistent dividend-paying blue-chip stocks.

2. How to choose bonds?

   • Prioritize Government Bonds (Treasuries): For defensive investors, safety is paramount. Government bonds, backed by the credit of the nation, have virtually no default risk and are the hardcore component of your "safety cushion."
   • High-Grade Corporate Bonds: Bonds issued by very creditworthy large corporations can also be considered. They offer slightly higher yields than Treasuries but also carry moderately higher risk.

Summary

As a defensive investor, your asset allocation strategy can be summarized in these steps:

1. Set the Baseline: Start with 50% Stocks / 50% Bonds.
2. Set the Range: Let your stock allocation fluctuate within the 25% - 75% band.
3. Adjust Counter-Intuitively:
   • Market exuberant, high valuation -> Sell some stocks, buy bonds (move closer to 25% stocks).
   • Market panic, low valuation -> Sell some bonds, buy stocks (move closer to 75% stocks).
4. Regular Rebalancing: Every six months or a year, check your allocation. If market movements cause stocks to rise too much, shifting your allocation (e.g., to 60% stocks), sell some stocks and buy bonds to bring it back to 50% or your target proportion. This action is called "rebalancing" and is crucial for keeping your portfolio within your defined parameters.

Remember, the essence of this strategy isn't predicting the market, but establishing a rule set that allows you to sleep soundly and automatically capitalize on market extremes. This is the true wisdom of the "Intelligent Investor."