Asset allocation

[Guest Gracey]

Hello everyone!

I recently read about this "rule of thumb" to use when determining how much money a particular individual should invest in stocks vs. bonds. Take the number 110 and subtract your age, this number is the % of your retirement that should be invested in stocks. I am concerned because for me, it comes out to 73% and currently I have 90% invested in stocks, (in a Target Retirement Fund). Does anyone have an opinion about this either way? I should mention that I was introduced to this concept in David Bach's book, Smart Women Finish Rich, which I found very informative. Any feedback would be greatly appreciated. Thank-you! P.S. I know David's book should be underlined, but I can't get the control to work.

[GMK]

Personal opinion, not expert advice:

The rule of thumb demonstrates that one should be more into stocks the further one is away from retirement. This is because historically stocks provide the highest return over the long run (past results are not a guarantee of future performance, but you go with what you know), and you have time for your stock investments to recover from dips (and drops) in the market before you need the money.

The closer you get to retirement, the more secure you probably want your retirement fund to be, so you transfer some of your stock gains to less risky investments. The idea of keeping some of your investments in stock is to try to generate additional returns that keep up with inflation. As you approach age 110, the overall possibility of your having less buying power due to inflation decreases.

Assuming you do not plan to retire in the next few years, 90% in stocks seems reasonable to me. And since stocks are down right now, this is probably not the best time to transfer out of those stocks. When you move some of your funds from stocks to less risky investments, think of it as taking some of your hard earned gains off the top and putting them into something where they will hold their own and are not likely to be lost due to downward market swings.

Hope this helps.

[Bird]

I think that rule of thumb is too conservative. It has some positive attributes; certainly it's easy, and it probably serves to help make some folks who are actually too conservative become more aggressive, to their benefit, but I just don't agree that a (typical) 40 year old who is saving to retire at 65 or so should be 30% in bonds (presumably the "not stocks" part is bonds). More like 0% (i.e. close to 100% stocks).

(I'm just talking about the long-term retirement fund; you certainly need some liquid assets.)

And if you're hoping to retire at 40, the answer is different (although not as much as you might think). But I think your mix is fine, assuming you have typical goals and assets on hand at your age.

[JanetM]

I have seen the same rule of thumb - number has varied from 100 to 140. I am 45 and 100% equity.

[John G]

Like any rule of thumb... simplicity may not necessarily produce a good fit for your circumstances. You need to temper "rules" based upon your circumstances. The concept assumes that as you get older you want to be more defensive and hold more cash/bonds. Some folks do, some don't.

Let me give you 5 exceptions:

1) You have a huge pension plan and great medical benefits (such as any executive, Senator or ex-President) you probably will not be drawing down as heavily upon your retirement assets...so you want a higher percent in equities because they will be invested for a longer period, perhaps for your heirs. Upon death, assets currently get a stepped up basis. If you sell them to buy bonds, you probably will be paying capital gain taxes.

2) You are especially good at picking stocks (I have a friend who runs a hedge fund that falls into this catagory) and it would be foolish to walk away from great investments to own bonds. Some folks investment performance drops when they diversify! Some folks seek to enhance performance by using margin! (generally non-retirement accounts)

3) Your assets are supersized and you don't expect to consume all of your nest egg. Would you advise Bill or Warren that they should own more bonds when they will never spend all of their assets? That's an extreme example, but I advise some folks with 10+ million in assets and its pretty clear they are not going to spend even half of that. If you have amassed a networth of 10 million, you are likely invested in equities, real estate, bonds etc. that might allow you to spend 1/2 million a year. If you only expect to draw $150,000 a year, you have a huge cushion.

4) Your family medical history suggests that you will live a very long time, or perhaps your spouse is much younger than you and is expected to live a long time. The longer your expect to live, the more you want to have in equities (aka stocks) which should outpace inflation. Ditto anyone retiring earlier.

5) You started late in accumulating for retirement and you want to maintain a high equity percent as part of a plan to boost returns.

Folks get the mistaken impression that they need lots of cash the day they retire. You don't. And, lots of folks live 30, 40 or more years after they retire.

Don't focus on the "rule". Do understand the underlying theory and figure what might work best for you.

I know dozens of successful people with over a million in net worth. They tend to be heavily invested in a diverse mix of equities. Many of these folks make their own stock picks. Some rely on ETFs or mutual funds. Most of this group has a high percent of their assets in equities.

No one seems to have noted that you said your assets were in a "Target" fund. Basically this is a marketing gimic created by the mutual fund industry to sell consumers on the idea of simplification and automation. Target funds supposedly adjust automatically as you age and approach retirement. Better than sliced bread ~ if you are the average person with a standard retirement date and actuarial life expectancy. What if you are retiring later, have more or less assets, specific health/longevity, a special spouse circumstance, etc.

Its sort of a mantra with me - - its your job to figure out what works best for you! Folks who farm out this responsibility to others often run into trouble. Spend some time reading about financial planning. Think about how you might be different from the average.