There’s a saying that younger people should invest more in equities (stocks) and older people should buy more bonds. Some like to use the “100 minus your age” rule to determine asset allocation. Start with the number 100 and subtract your age. The resulting figure is the percentage you should allocate to equities, and the rest should be invested in bonds. For example a 30 year old investor could have the following portfolio:
70% = Vanguard Total World Stock Index Fund Investor Shares (VTWSX)
30% = Vanguard Total Bond Market ETF (BND)
This simple yet balanced portfolio should benefit from the long term growth of the U.S. and global markets, while providing fixed income stability 🙂 But should everyone follow this rule of thumb? Probably not. Age should not determine our asset allocation. Consider the following situations.
U.S. government 10-year bonds today only pay about 2.5% interest a year. But ten years ago they were paying twice as much. This means in order to achieve an adequate return on a fixed income portfolio today we would have to mix in higher risk investments such as non-investment grade bonds and mortgage backed securities. However at some point the risks will not be worth the expected returns. So in a low interest rate environment it may be prudent to lower our exposure to bonds, and stock up on more equities instead, at least until interest rates move higher.
Three decades ago those 10-year government issued bonds were paying 15% interest a year due to a more robust economy and higher interest rates. In that kind of situation we want to be overweight in bonds because the 15% annual return is virtually risk free since it’s guaranteed by the U.S. federal government 😀
If a young person in his late twenties has $50,000 in savings, what should he invest in? We see questions like this on Reddit all the time, but it’s impossible to give a categorical answer without knowing the individual’s personal situation. If he plans to buy a home in a couple of years using his savings as a down payment then he should probably avoid risky investments and be 100% in bonds. On the other hand if he has no plans to purchase a big ticket item, and he works for a State university that offers a generous fixed income retirement plan, then he should probably invest most of his own savings into growth stocks.
What about seniors? They have their own set of circumstances to deal with.
If a senior widow in her seventies has $500,000 to invest, the knee jerk assumption is she should load up on bonds and other conservative, income producing assets. But if she can already live comfortably on the income she receives from insurance benefits, a private pension, and social security, then maybe she should invest 100% of her personal savings into S&P 500 dividend aristocrats instead, which are blue chip stocks that have a long history of steady dividend growth. Stocks tend to outperform bonds in the long run so a longer time horizon benefits stock investors. If her grandson is expected to receive a part of her inheritance eventually then she may as well put the money to work in the stock market right now to begin with, because he would just invest his eventual inheritance in blue chip companies anyway, and not in low yielding bonds. Furthermore, the dividends can provide her with some extra spending money right now, and she can always dip into the capital for emergencies. Dividend aristocrats can weather recessions quite well. Everybody wins 😀
At the end of the day investment decisions should not be based on our age. It’s our own circumstances that should dictate our risk tolerance and propensity to favor one asset class over another. It just so happens that in many cases the younger we are the more risk we can afford to take on. But causation does not imply correlation and it’s important to understand the reasons behind why we should do the things we do, especially when it comes to our finances.
My personal allocation in terms of liquid assets is 10% fixed income, and 90% equities at the moment. I believe this is the optimal ratio for myself given my situation 🙂 What’s yours?
Random Useless Fact: