When it comes to asset allocation, stocks vs. bonds, almost every money management book I have read suggests that a person should have a higher percentage of bonds in their portfolio as they grow older. All of those books use age as the major determining factor.
The Bond Vs. Stock rule of thumb
One rule is thumb is your age should represent the percentage of bonds you have. If you are 20 years old, you should have 20% in bonds. If you are 30 years old you should have 30% in bonds. So on a so forth.
I think this is ridiculous. These rules of thumb are slowing down the growth potential of a young person right from the earlier years. And right when that person has the ability to take most risk.
It’s my opinion that a 20-year-old person should not have any part of his portfolio in bonds. Stocks grow at about 8% per year. Bonds grow at about 2% per year. People buy bonds because they want less volatility. But at 20 years, the amount of money is not that much and the young person can withstand all kind of volatility.
Bond Vs. Stock according to the amount of money
Example 1. Daniel is 55 years old and he only has $10,000. Does it make sense to put 55% in bonds? To protect it against what? Considering the cost of living in the US or in Canada, $10,000 would not take him too far. Daniel will have to find lots more capital if he wants to retire one day, or he will have to work way past his retirement years. The amount of bonds vs. stock is irrelevant, but if I was him, I will put 100% in stocks. I don’t have much to lose. Why not take a chance.People should not be placed in a nice cookie cutter formula.
Example 2. Maria has a portfolio of $10,000,000. Maria could be 100% in bonds no matter what age she is. Why would she take any risk at all? Even at today’s low bond yields of 2%, Maria would receive $200,000 every year. Age is not a factor when we consider the asset allocation of Maria.
Example 3. Louis is 65 years old. He has a portfolio of $500,000. He also has a fixed pension that gives him enough to live. As far as I know, Louis could have a portfolio of 100% stocks. No matter what risk he takes, he is covered. If he lives to 85 years, his money has 20 more years to grow. His kids and grand-kids will be very happy.
Example 4. Carla is 75 years old. She has a portfolio of $1,000,000 and her living expenses are only $50,000./year She wants to leave whatever money is left to her daughter age 50 and her grandson age 25. It’s the same money but the beneficiaries are three different ages. How do you square that hole? Carla is 75, the daughter is 50 and the grandson is 25. Should the money be invested thinking of her? of her daughter? or her grandson?
As you can see in these examples, age is not the most important factor. The amount of money is the most important factor.
Where do you fit in? What are your special circumstances? How much money do you have to support the life you want to live? How much money do you want to leave behind?
Bonds are not safer than stocks
You hear it all the time: “Bonds are safer than stocks.”That’s simply not true. Bonds are less volatile than stocks, but they are certainly not less risky. Here is a chart of the stock market returns for any 20 year time period. If you notice, the S&P has never lost money in any 20 years time period. Yes, there is a lot more volatility when you are 100% in stocks, but over any 20 years period, the risk of loss has been 0%.
How I would allocate my money
This is quite personal, so don’t apply it to your life, unless your life is similar to mine and you have similar objectives.
My lifestyle is very frugal. I live on less than $24,000 per year ($2,000 per month).
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One way to figure out how much I need to live is by applying the rule of 4. If divide my annual expenses by 4%. I get $600,000. So, if $600,000 is my number. I would put in bonds any amount over $600,000. If the market drops, I would transfer money from my bond holdings to stocks.
One of the things that I am careful of, is of not doing too many transactions. Is better to let money be invested and left alone. The more I play with my portfolio, the greater the chances of string away from the original plan. My transactions are only done once a year, the second week of December, so that I can report my gain and loses in my current tax
As it is right now. At age 50, I am 45% in stocks and 55% in real estate. I am trying to get rid of my real estate to be 100% in stocks. And if you are wondering… NO, I haven’t reached the $600,000 mark.
A question for you
Will you use age or amount of money as a determining factor for your bond allocation?
What would be the trigger point to switch from stocks to bonds? At what age? How much money?
This article has been republished with permission from Alain Guillot.