Do you ever wonder if you are over-invested in stocks? Heck, once you’re retired, you may wonder if you should even own stocks at all.
I get this question from people in their 80’s to folks in their 50’s. So, let’s talk about it. Do you ever “outgrow” having stocks as part of your investment portfolio?
It’s a legitimate question. After all, compared to cousin investment vehicles like bonds, stocks are considered higher risk. But it’s helpful to remember that stocks can also bring higher rewards. Any investor with significant experience in the market understands this reality.
It’s also true that no one really knows if stocks will be worth more or less in a decade, a year, or even a day! The crucial point for investors to remember is that time in the market is far better than attempting to time the market, and having a healthy mix of investments is emotional insurance against the inherent volatility of stocks. Staying in the market over time with a diversified portfolio can help you stay the course when things get a little (or a lot) rocky.
When the topic of outgrowing stocks comes up, many financial professionals will recommend the Own Your Age in Bonds (OYAIB) rule. This rule of thumb says the percentage of bonds in your portfolio should equal your age. Let’s say you’re 35. Under OYAIB, 35% of your money should be in bonds. For someone who’s 70, then, you guessed it, 70% of their assets should be bonds.
OYAIB is based on the idea that, as we get closer to retirement, we want to trade the growth potential and volatility of stocks for the relative safety and predictability of quality bonds.
Now, OYAIB isn’t the worst rule in the world. But if you ask me, it makes less sense today with the dramatic shift we’re seeing in the bond market.
As interest rates fall, bonds go up. At least that was the trend for 30 years – until mid-2016 when rates started to inch steadily higher from historic lows. So, we could be in for 20 or 30 years of the inverse of what we’ve seen. That means the roughly 7.5% annual return bonds have averaged since 1976 would be unlikely to materialize over the next 40 years. Take a look at the information below for some historical perspective.
Average CPI since 1913: 3.25%
Average CPI since 1928: 3.06%
Average CPI since 1976: 3.69%
Average S&P 500 since 1928: 11.53%
Average 10-Year T-Bond since 1928: 5.15%
Average 3-Month T-Bill since 1928: 3.44%
Average S&P 500 since 1976: 12.72%
Average Agg Bond since 1976: 7.41%
Average 10-Year T-Bond since 1976: 7.65%
Average 3-Month T-Bill since 1976: 4.61%
Now, consider this equally important point: These days, we’re living longer. It’s not uncommon for your retirement to last 25 years or more. Depending on how much you’ve saved over the decades, funding such a long stretch of life might require you to take at least a bit more risk than earlier generations of retirees.
That means owning more stocks. And it gives us the answer to our question: No, most of us never really outgrow owning stocks.
So, if you believe you’re an investor with a “moderate risk tolerance” (or higher), consider skipping the OYAIB approach, and looking instead at a rule of thumb that’s considered more timely and effective.
I call this new guideline the 15/50 Stock Rule. It’s relatively simple to follow. If you believe you have more than 15 years left on this planet, your portfolio should consist of at least 50% stocks, and the remaining balance in various bonds and cash. This new rule of thumb tries to help you always strike a balance between risk and reward.
You don’t have to take my word for it. The 50/50 portfolio idea has been around for decades. It was most prominently championed by Warren Buffett, who is considered the father of value investing and the person most responsible for shaping the investment philosophy. Another fan of the 50/50 strategy is Vanguard founder John Bogle, who sees it as the ideal strategy for defensive investors.
The stock allocation can be made up of either dividend-payers or growth stocks. You just need to keep an eye on your portfolio and reallocate as necessary to prevent stocks from creeping beyond the 50% mark.
As Benjamin Graham explained, “When changes in the market level have raised the common-stock component to, say, 55% the balance would be restored by a sale of one-eleventh of the stock portfolio and the transfer of the proceeds to bonds. Conversely, a fall in the common-stock proportion to 45% would call for the use of one-eleventh of the bond fund to buy additional equities.”
Of course, a 15/50 Stock Rule portfolio requires a tad more risk tolerance than one based on OYAIB, especially if you are in your 70’s. But, in my opinion, this new rule makes much more sense in the current and near-future investment environment. It’s worth considering, and perhaps talking about with your financial planner.