If you’ve ever picked up a personal finance book, you’ve probably run into this retirement investing maxim or one like it: “Own your age in bonds, own the difference in stocks.”
If you followed that idea to the letter, you would be in an 80/20 portfolio of mostly stocks as a young person starting out and then, in your retirement years, the numbers would flip. As a 70-year-old you would own 70% of your investments in bonds and the balance in stock.
Like with any rule of thumb, the purpose is to simplify what can be a complex idea. And generally it’s true that you should own riskier and thus potentially higher return investments when you are young. That means stocks.
The reason why is precisely because you have time. If the stock market takes a big dive, and it will, you have decades to recover.
It’s better than that, in fact. If stocks decline in value you get to buy more of them at cheaper prices. Presumably, you will be investing steadily over all of those years.
The problem with the age-to-bonds logic is that it can be taken too literally and in a way that’s out of context with your actual situation. If you are saving in a 401(k) plan, an IRA or other qualified accounts and have no other resources at all, the model is pretty good advice.
However, if you have a pension, Social Security income or other assets outside tax-deferred plans, such as an inheritance, real estate you intend to sell or stock options from an employer, you might be investing in a way that’s too conservative.
The problem, again, is time. If you expect to live exactly 10 years in retirement and then die peacefully in your sleep, well, perhaps things will work out. If you or your spouse lives well into your 90s, or both of you do, a conservative, bond-heavy portfolio might become a problem.
The reason is inflation. Some types of bonds account for it but most don’t. Stocks, however, have shown a resilience to the constant watering down of purchasing power. While a stock-filled portfolio might be a big risk for an older retiree, a stock-light portfolio can be a real risk to a young retiree.
They key is to assess, at least annually, how long you expect to need your money, how much income you need from your retirement savings, and how much you can really put at risk in exchange for inflation protection.
In that sense, a simple walk-through of some some basic risk-tolerance questions can make all the difference in the outcome, and it’s a process you should undertake at least annually.
While the rules of thumb are helpful, they have limits. Make sure you don’t outlive your money by measuring all of the risks you take over decades of saving and investing, and be thoughtful about what’s an appropriate portfolio mix for you.