2998: The “Minus Your Age” Rule of Thumb for Asset Allocation by Craig Stephens of Retire Before Dad

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[00:00:59] This is Optimal Finance Daily, the minus your age rule of thumb for asset allocation by Craig Stephens of RetireBeforeDad.com.

[00:01:10] The minus your age rule of thumb is a simple math formula used in personal finance to help DIY investors and advisors determine a suitable stock-to-bond ratio for an investment portfolio.

[00:01:24] I've always referred to this as the 130 minus your age rule of thumb on this website, but that only tells part of the story.

[00:01:32] The 130 value is the formula constant. Then we subtract our age to get a ballpark target stock allocation for our investment portfolios.

[00:01:43] The remaining percentage goes to bonds. As I dug into the origins of this rule of thumb for this article, I found a lot of wiggle room in how we can use it.

[00:01:54] The 130 minus your age rule of thumb. Here's how I've always used the rule of thumb.

[00:02:01] 130 minus your age equals the percentage of portfolio in stocks.

[00:02:06] I'm 49, so my calculation looks like this.

[00:02:11] 130 minus 49 equals 81% stocks and 19% bonds.

[00:02:17] The 130 value is an aggressive place to start, but I've consistently tweaked the outcome further to match my risk tolerance, which is a bit higher.

[00:02:27] This simple method for targeting an ideal stock-to-bond asset allocation has been around for a while.

[00:02:33] But its use has gotten more aggressive in the last few decades.

[00:02:38] The 100 minus your age rule of thumb. Your age in bonds.

[00:02:43] The idea that investors should have their age in bonds was a common adage back in the more conservative days of financial planning.

[00:02:52] Age in bonds is the same as 100 minus your age.

[00:02:56] So if I were to implement this asset allocation at my age, my numbers would look like this.

[00:03:02] 100 minus 49 equals 51% stocks and 49% bonds.

[00:03:08] Having just 51% of my portfolio in stocks is far too conservative for my risk tolerance and anticipated investment horizon, which is decades.

[00:03:18] However, back in the day, advisor clients were much more skeptical of the stock market because the 1929 crash and the Great Depression were a less distant memory.

[00:03:30] Plus, war and widespread smoking led to shorter lifespans.

[00:03:34] So being this conservative may have been the appropriate strategy for many.

[00:03:39] Vanguard founder Jack Bogle recommended the age in bonds rule of thumb for young and old and said he used it himself later in life.

[00:03:47] The 120 minus your age rule of thumb.

[00:03:52] I likely first heard about the 120 minus your age rule of thumb in a CNBC interview sometime between 1994 and 2012, when I was an avid watcher and listener.

[00:04:04] The 120 rule of thumb is probably the most common reference to this asset allocation method.

[00:04:11] Here's how it would look for me.

[00:04:12] 120 minus 49 equals 71% stocks and 29% bonds.

[00:04:19] By the 1980s and 1990s, advisors realized that investors could be more aggressive as lifespans increase and long-term stock market returns are more reliable as investment horizons expand.

[00:04:33] 120 builds on age in bonds by bumping up the stock allocation by 20 percentage points.

[00:04:39] Jack Bogle also recommended 120 in interviews over his career.

[00:04:45] He was an influential voice for decades, and his thousands of enthusiastic fans still reference and follow his wisdom.

[00:04:54] One point he certainly drove home throughout his lifetime was that age should influence stock-to-bond allocation, and we should increase bond holdings as we age.

[00:05:04] Another legend of finance shared this view.

[00:05:07] The 115 to 140 minus your age rule of thumb.

[00:05:12] A more academic and data-driven version of the minus your age rule of thumb emerged in a 1996 article in the Journal of Financial Planning by a famed financial advisor named William Benjen.

[00:05:27] Benjen is best known for laying the mathematical groundwork for the 4% rule of thumb, a fire handy tool.

[00:05:35] As Benjen's client lifespans increased, he was receiving a lot of questions about the ideal stock-to-bond ratio in a retirement portfolio.

[00:05:44] So he ran the math using historical market data and a 4.1% safe withdrawal rate.

[00:05:51] The outcome was the article in which he advocated using a range, tailoring the minus your age constant based on risk tolerance and current age.

[00:06:01] The article is primarily focused on retirement accounts.

[00:06:05] To cover all risk tolerances, he combined the three numbers into one formula.

[00:06:11] Your percentage of portfolio in stocks equals 115 to 140 minus your age.

[00:06:18] With my aggressive attitude towards investing and long-term investment horizon, I re-ran my number using 140 and I got this.

[00:06:28] 140 minus 49 is 91% stocks and 9% bonds.

[00:06:33] And that's just about where my portfolio is right now.

[00:06:37] 90% stocks and 10% bonds.

[00:06:40] So I actually like this framework better than just using 130 because differences in risk tolerance are built in and there's data behind the study to back it up.

[00:06:50] In the future, I'll likely continue to refer to this as the 130 rule of thumb because it's near the moderate point and easier to remember.

[00:07:00] And that's why there are rules of thumb and not laws.

[00:07:05] Personal finance is littered with rules of thumb but devoid of concrete laws.

[00:07:11] That's because nearly everyone's situation, life experiences, and risk tolerance are personal.

[00:07:18] Navigating rules of thumb, like minus your age, requires taking in many data points to determine before executing a plan.

[00:07:26] I recently went through this exercise with my parents when they left their financial advisor after 20 years.

[00:07:32] We took a broader view of their assets and income, which include an ironclad teacher's pension that covers their expenses.

[00:07:39] My dad's pension allows us to be more aggressive with their allocation percentages, falling at around 132 minus his age.

[00:07:49] That was a foundation based on recent risk-free high-yield savings and interest rates.

[00:07:55] As we approach annual rebalancing, we'll re-evaluate the current situation and likely add another 1-2% to bonds, just as Bogle and Benjen advised.

[00:08:07] Remember that even if you reach your target asset allocation, the next day it will change when the market opens.

[00:08:14] Wait at least a year between substantial portfolio reshuffling.

[00:08:18] The simpler the portfolio, the easier it is to maintain an appropriate asset allocation.

[00:08:28] You just listened to the post titled, The Minus Your Age Rule of Thumb for Asset Allocation, by Craig Stevens of RetireBeforeDad.com.

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[00:10:55] I think before you figure out how much of your portfolio should consist of bonds, it's worth considering what purpose bonds play in your portfolio and why they're related to your risk tolerance.

[00:11:08] I think of risk tolerance as contingent on your time frame of when you're going to tap into your portfolio, as well as your reactions to market volatility.

[00:11:18] The stock market is like a roller coaster.

[00:11:20] You're going to watch your portfolio rise and fall as the market rises and falls.

[00:11:25] But over the long term, I'm talking decades, the stock market always goes up.

[00:11:31] This is why it's important to invest your money for the long term.

[00:11:35] Bonds make your portfolio more stable, so you'll experience less wild swings as the stock market goes up and down.

[00:11:43] The downside is that you trade return for more stability.

[00:11:46] This is why I don't hold any bonds.

[00:11:50] It's very possible that I won't touch my investments for another 30 years.

[00:11:54] So even if there are wild swings, I have plenty of time to recover.

[00:11:58] And I'm not worried about panic selling.

[00:12:01] I fully expect my portfolio to drop 10, 20 or 30 percent at some point.

[00:12:07] It's simply the nature of investing.

[00:12:10] As I get closer to drawing down on my portfolio, I will add bonds to smooth the ride and reduce the chances that I'll need to take money from my portfolio when it's down.

[00:12:22] But that should do it for today.

[00:12:23] Have a happy rest of your day, and I'll see you on the Thursday show tomorrow where your optimal life awaits.