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Savvy investors know that selecting the right mix of stocks, bonds and cash is key to meeting long-term goals. At least, that’s what we’ve been told — over and over and over.

But how have different combinations actually performed?

Mutual fund company T. Rowe Price (Stock Quote: TROW) has looked at five portfolios from the start of 1950 through the end of 2009, reaffirming the long-held belief that stocks are key to beating inflation and achieving maximum growth. Bonds and cash play supporting roles, stabilizing a portfolio during stock market gyrations and providing liquidity.

Over the 59 years, stocks provided the greatest return, averaging 11% a year. Bonds averaged 6.1%. The all-stock and all-bond portfolios duplicated those records.

Stocks, of course, are much more volatile, losing an average of 12.5% in the down years, for example, versus a 1.6% loss for bonds. Stocks had 14 down years, bonds had 8. Stocks' whipsaw performance was also reflected in standard deviation, a measure of an investment’s up and down swings. Stocks registered a high 18, bonds a much less volatile 6.4.

In addition to the all-stock and all-bond portfolios, T.Rowe Price looked at three with different asset mixes:

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  • The most conservative mix held 40% stocks, 40% bonds and 20% cash. It returned 8.1% a year, lost 11.5% in its worst year and gave up 3% in its average down year.
  • A middle-of-the-road portfolio of 60% stocks, 30% bonds and 10% cash returned 9.2% a year, lost 20.4% in its worst year and surrendered 6.4% in its average down year.
  • An aggressive portfolio of 80% stocks and 20% bonds, returned 10.2% a year, lost 28.6% in its worst year and fell 8.8% in its average down year.

T. Rowe Price pointed out that while diversification can dampen the up and down swings, it cannot guarantee there will be no loss at all. The conservative portfolio had 11 down years, the middle one 12 and the aggressive one 14.

During the 59 years, inflation averaged about 3.7%. When that figure is subtracted from each of the performance numbers, it is clear that stocks returns are key to keeping ahead of inflation. After-inflation gains averaged only 2.4% for the all-bond portfolio, versus 7.3% for the all-stock portfolio, for example. The report on the study notes that 30-day Treasury bills, a common measure for cash returns, earned just 1% a year with inflation taken into account.

The study also looked at rolling 20-year periods — the 20 years beginning Jan. 1, 1950, Feb. 1, 1950 and so on. Stocks beat inflation in all 480 periods, while long-term corporate bonds lagged inflation 29% of the time and long-term government bonds lagged 40% of the time.

Despite stocks’ superior performance, T. Rowe Price says even long-term investors should own some bonds, or bond funds, to soften the bumps in the road. During the 59-year period, a portfolio of 80% stocks and 20% bonds would have produced 93% of the return of a 100% stock portfolio but with only 80% of the volatility.

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