Capital Investment Advisors

Why You May Want To Look Under Hood Of Your Target-Date Fund

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Asset allocation. Portfolio rebalancing. Dollar cost averaging. These are all different investment concepts that Americans use to prepare for and navigate a happy retirement. I’d like to introduce an additional one that typically garners a little less press but that I believe can be just as helpful. It’s the 15/50 Stock Rule, and it’s a concept that I encourage in place of using the older rule of thumb to Own Your Age in Bonds (OYAIB).

Let’s take a step back. Naturally, nobody wants to run out of money, but since death’s date is a dish best served unknown, it can be hard to know when to throttle back on the investment accelerator. This, in combination with the market trends of the past 20-30 years, has led to a giant market of overly cautious investment behavior.

Roughly $3 trillion of American investments sits in something called target-date retirement funds. The idea of a target-date fund is to select a likely future retirement age, turn on cruise control, and let the robots do the rest. As that date gets closer, your fund automatically becomes more and more conservative so that the chance of “losing it all” when the income stops flowing is lowered. As you age, many of these funds continue to become even more cautious throughout retirement and end up heavily weighted toward bonds, with little stock exposure.

Much of the target fund industry is rooted in the OYAIB rule: The percentage of bonds in your portfolio should equal your age. If you’re 35, 35% of your money should be in bonds. Age 75, 75% in bonds, and so on. Bonds are considered a more conservative and safer investment than stocks. The idea is that as a person ages, more and more of their investments are sheltered from stock market volatility.

In my opinion, OYAIB isn’t the worst rule in the world, but it makes less sense today for a couple of reasons. First is the dramatic shift we’re seeing in the bond market and the lowest interest rates we’ve seen in a generation. That doesn’t bode well for bonds. Second, these days people live longer. It’s not uncommon for retirement to last 30 years or more. Average life expectancy was shorter, and interest rates on bonds were higher, when OYAIB was first established.

The problem is that many retirees and early retirees could potentially become too conservative in these automatic vehicles unless they start thinking about their time horizon in a new way. Enter the 15/50 Stock Rule.

The 15/50 Stock Rule is relatively simple to follow. If you believe you have more than 15 years left on earth, your portfolio should consist of at least 50% stocks and the remaining balance in various bonds and cash. This paradigm shift seeks to ensure you strike a balance between risk and reward.

Adopting a long-term investing mindset in a diversified but not overly cautious portfolio can traditionally lead to solid growth. Imagine earning 6% to 8% annually over the course of many years.

Now, this isn’t a call to invest 50% of your life savings into the latest “hot stock tip” your 19-year-old barista offers you. You’ve probably heard the adage that investing is simple but not easy. Well, I think we’re living through a perfect example of that. When the headlines are filled with meme stock millionaires and crypto-currency booms and busts, it’s easy to feel FOMO (fear of missing out) and behind the ball. While being caught up in this meme stock storm is exciting, it’s not a durable investment strategy that has been historically shown to withstand the test of time.

The 15/50 Stock Rule is a way for you to start thinking about how much money you want to have in the equity or stock markets even when you get into retirement. To some extent, the retirement industry was predicated upon investors becoming more conservative over time. If you open up the hood and look at what many target-date funds look like closer to or into retirement, it can be concerning because they may have only 20% or 30% in total stocks, with the rest in bonds. This may not be the right hedge against inflation. And that’s why I think the 15/50 Stock Rule is such an important strategy to consider.

Many years ago, I was fortunate enough to interview the founder of Vanguard, John Bogle, who did so much for so many investors. One of his early philosophies was that the concept of owning your age in bonds was developed during a period of time when the bond market had a really impressive run.

If you go back and look at the 10-year Treasury bond since 1928, you’ll see that it’s returned a little over a 5% average annual rate of return. If you start the clock in the mid-1970s, that average annual rate of return is even higher, at 7.5%. That’s not too far from the roughly 12% that we’ve seen in the stock market. But it’s important to understand that we were in an environment that provided a real tailwind for bonds.

Coming out of the financial crisis and global pandemic, interest rates have essentially gone to zero. In fact, the Federal Reserve has kept short-term interest rates at zero. I believe the natural course for interest rates is to move higher over the next five, 10 and 20 years. And again, if interest rates climb higher, that means bond prices will move lower.

I’m not saying that we shouldn’t have any bond investments. I think it’s still a very important place for safety and stability, particularly for more conservative investors. But are we going to get 7% per year out of bonds over the next decade per annum? I doubt it.

That’s why I’d like to encourage folks to consider graduating from this thinking of “own your age in bonds” to the 15/50 Stock Rule.

For example, I just looked at the Vanguard Target 2015 Fund. I’m not going to say there’s anything right or wrong with it, but imagine you were 62 in 2015. You retired and this is the fund in which you have your retirement assets. Fast-forward to 2021. You’re now only 68 years old, but the allocation has climbed to almost 70% in bonds and dropped to around 30% in stocks. You would find yourself relying on the bond portion to outpace inflation and that’s a tall order.

Most of us never really outgrow the importance of owning stocks as a hedge against inflation — no matter how old we get. So, if you’re headed into retirement with even a moderate risk tolerance or higher, I think it might be time to consider the 15/50 Stock Rule.

I’m not the only advocate for this philosophy. It was most prominently championed by Warren Buffett, who got the idea from a professor named Benjamin Graham. He essentially said that if you don’t know exactly what your investment mix should be, whether you’re 30, 50 or 80, having 50% in stocks and 50% in bonds is always a good mix.

Remember that most of us are investing for much longer periods of time than we realize. In fact, you might want to consider your investment time horizon as some version of forever. The 15/50 Stock Rule can help you get there.

Read the AJC Article here.

Disclosure: This information is provided to you as a resource for informational purposes only and is not to be viewed as investment advice or recommendations. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.

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