Asset Allocation: The Myth of the Portfolio that Acts your Age

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Harold Evensky CFP® , AIF® Chairman

Policy research is great for policy makers but may be poison for you.

I just finished reading an article in a professional journal that reported on extensive research about how people of different ages divide their investments between stocks and bonds. It went something like this.

Our research, based on zillions of responses to trillions of questions, has determined that investors at age forty have 60 percent of their funds in stocks and 40 percent in bonds. Investors at age seventy have 70 percent in bonds and 30 percent in stock. Further analysis, to a high degree of statistical significance, has determined these proportions are close to the proper allocation of resources for the average investor of these age groups.

 Therefore, we have concluded that, based on our studies, investors should use the following formula to determine the percentage of stocks and bonds in their portfolios:

  • The amount to be invested in stocks = (100 – the investor’s age)
  • The amount to be invested in bonds = (100 – the amount invested in stock)

What a terrific solution to how you should invest your money. No muss, no fuss. All you need to know is your age and the rest is just simple math that you can do in your head. If that seems too easy, there are many companies and magazines that provide more detailed suggestions about how to invest your money based on your age. All of these approaches are based on a concept known as life-cycle investing. The general idea is that your financial needs are related to your age. The approach is endlessly popular and sounds terrific. There’s only one problem: it’s hogwash!

Wait, that’s not fair. If you happen to be a sociologist or a government policy maker, this might be terrific stuff. After all, sociology is the study of large groups. Still, it’s dangerous hogwash if you try to use it to plan your own life. Remember, sociologists are the professionals who came up with the concept of families with 1.8 parents and 2.3 children.

Since you’re probably not a sociologist or policy maker, and are more interested in your unique needs than the statistically average needs of everyone your current age, the cookie cutter—life cycle approach—to planning won’t work for you.

Let me tell you about two of my clients, the Salters and the Boones. When we first worked with them, my partners and I were amazed at how similar these two families seemed. Both families not only live in the same city, they also live in the same neighborhood, just two blocks apart, in houses of the same model, built the same year by the same builder. Mr. and Mrs. Salter and Mr. and Mrs. Boone are working professionals. When we met them they each were fifty-five years old, in good health, and they planned on retiring when they reached sixty-two. The coincidences seemed endless. We thought they even looked alike! Both had investment portfolios valued at $1,000,000 at that point, and they all considered themselves moderately conservative investors. Because neither the Salters nor Boones have children, they have no desire to leave an estate.

Well, if lifestyle planning worked, these two couples’ investment portfolios should look alike. Lucky for our clients we are financial planners and we gathered more information. Here’s what we discovered:

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How about that? To a sociologist, these couples looked alike; to a financial planner, based on their savings rate, their retirement income, and financial goals they looked very different. Let’s see how our recommendations differed from the life-cycle solution.

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Note that the life-cycle recommendation is the same for the Salters and Boones. That seems a little strange because the Boones plan on spending a lot more than the Salters in retirement, and the Salters are saving more between now and retirement and have significantly more Social Security income. The fact that their ages, risk tolerance, employment, home, health, and planned retirement dates are similar is irrelevant.

After careful analysis and based on the information specific to our clients, we made the following recommendations:

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It sure doesn’t look like the 55 percent bond formula you’d get by subtracting their age from one hundred. Why the difference? In spite of similar demographics, the Salters and Boones have very different resources and goals. Remember, you’re unique and planning based on simple rules of thumb can be a mighty dangerous way to plan the quality of the rest of your life.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

The “Magic” of Asset Allocation

John R. Salter, CFP®, AIFA®, Ph.D. Principal, Wealth Manager

John R. Salter, CFP®, AIFA®, Ph.D.
Principal, Wealth Manager

The recent turmoil in the financial markets has led many investors to think about their portfolio and whether it is helping them to meet their financial goals. One of the most important aspects of your portfolio is asset allocation—the amount you should invest in various asset classes with the ultimate goal of maximizing return for a given amount of risk.

What is an asset class? A simple description is a group of similar investments that have differing risk and return characteristics than other groups of similar investments. For example, stocks have different risk and return characteristics than bonds, and they do not behave in exactly the same way. When stocks go up, bonds don’t necessarily follow. For this reason, stocks and bonds are not correlated. We seek to create an asset allocation made up of multiple, non-correlated asset classes in order to meet a client’s long-term financial goals.

The returns (and associated risk) of a portfolio are heavily impacted by the asset allocation decision. In fact, a study by Brinson, Hood, and Beebower found that 94% of the difference in return variance among more than 90 pension plans was due to asset allocation—not what particular security was chosen or timing the market.

Another important factor, related to asset allocation, is diversification. Owning a single stock is an example of a non-diversified portfolio. But say you owned two stocks—Apple and Google. Since these companies are both in the technology industry, it still wouldn’t be sufficient diversification. A well-diversified stock portfolio would include U.S. companies, international companies, small companies, and large ones, as well as both value stocks and growth stocks. Similarly, a bond portfolio should include both government and corporate bonds, high- and low-quality bonds, and short-to-long maturity bonds in order to be considered well-diversified.

Ultimately, your asset allocation should be determined based on two things: your personal financial goals and your need and tolerance for risk. Even a well-diversified portfolio invested 100% in stocks is still considered to be high-risk. In some ways, risk tolerance is designed to measure your “pain point,” the drop in value that would cause you to sell your portfolio during a market downturn. Our emotions often tell us to sell when we have suffered a large loss, when the right thing to do is buy. I can’t tell you how many times I have heard people reference selling everything in 2008–09 after losing a large portion of their portfolio; this is often done at the worst time. The right way to approach the issue, if you own both stocks and bonds and stocks fall, is to sell bonds and buy more stocks; this is known as rebalancing. It may seem counterintuitive, but the research shows that it works over the long run. Find an appropriate mix of stocks and bonds based on your appetite for risk (a moderate-risk portfolio is generally accepted to be 60 percent stocks, 40 percent bonds), and work to maintain that mix over time.

It is impossible to know what will happen in the markets over time. Asset allocation allows us to capture the returns of a number of different asset classes and can help to reduce the risk of your overall portfolio. While it isn’t really magic, asset allocation works much better than either a crystal ball or a Magic 8 Ball. We have both in the office, and I can assure you neither works very well.

Thanks for reading hope you enjoyed! As always feel free to contact John Salter with any questions 806.747.7995 or