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Age-Based Asset Allocation (I’m Not a Fan)

A reader writes in, asking:

“I am curious for your take on the age-in-bonds rule of asset allocation. It seems to me that maybe it’s a bit out of date, and today higher stock allocations are called for.”

I have never particularly been a fan of the “age in bonds” rule. But that’s not because I think that it needs to be adjusted to “age minus 20” or anything like that. Rather, I think that age is simply not a very good stand-in for risk tolerance.

For example: consider my wife and me. When we were 25, our incomes were pretty modest. Our assets were very modest. Our Roth IRAs were definitely not intended to function as emergency funds, but it wasn’t at all out of the question that if a large unexpected expense came up, that’s where we’d be going for the cash necessary to pay the bill. It would have been either raid the Roth IRAs or put it on a credit card. Point being, despite being young, we simply had a limited financial ability to take on risk.

Today, we’re both age 40. And there’s no question that our ability to take risk is greater than it was at age 25. We’re still far enough from retiring that a market decline wouldn’t throw off our plans in any meaningful way. We now have considerably higher household income. After 15 more years of saving and investment returns our assets are dramatically greater than they were at that time. And now the portfolio isn’t doing double-duty as an emergency fund in the way that it was at age 25. We are now more financially secure in every way.

15 years older, but with much greater ability to take on risk in the portfolio. And there’s nothing remotely weird about that set of circumstances. That is in fact the normal path for a household’s finances to take, over that particular age range.

Or consider this example: Jimmy and Bob are two unmarried retirees, who have completely identical finances (identical portfolios, identical Social Security income, both spending let’s say 4% from the portfolio per year, etc.). The only difference is that Jimmy is age 65 while Bob is age 95.

Bob has a greater ability to take on risk than Jimmy does. At age 65, Jimmy’s portfolio is still overwhelmingly a retirement portfolio (i.e., intended largely for the purpose of funding his own spending during retirement). For Bob at age 95 with a 4% spending rate, there’s functionally zero chance of running out of money during his lifetime; a large portion of his portfolio is now a bequest portfolio.

Again, the older person has a greater ability to take on risk. And again, there’s nothing particularly weird/unusual about that hypothetical. It’s not rare for it to become clear at some point that the portfolio is, to a significant extent, now being invested on behalf of one’s intended heirs rather than on behalf of one’s own self.

All of this isn’t to say that the ability to take risk always goes up with age, because that’s definitely not true either. Rather, there are specific times in a person’s life where a risky portfolio is simply more dangerous, such as:

  • Very early in the career when the portfolio is also the emergency fund and income/assets are very limited, and
  • In the few years right before and right after retiring.

I think, rather than any age-based rule, it’s prudent to actually look at your own household’s specific circumstances: how harmful would a major stock market decline be, for you, right now? And the answer to that question (regardless of your age) pretty well informs the question of what asset allocation is likely to be appropriate. (And as always I’ll note that for any one household, there’s not one single allocation that’s “correct.” There’s a whole range of allocations that would be reasonable.)

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