"We are made wise not by the recollection of our past, but by the responsibility for our future." - George Bernard Shaw
With great pleasure, it's time to break down a financially dangerous rule of thumb. "Your age should represent the % of bonds in your portfolio." Sound at all familiar? This “rule”, thankfully, is not as prevalent today as it once was. Given today’s circumstances, this could be a very risky rule to follow. Hearing it as many times as I have, it is very important to break down and understand. I believe this rule to be completely without merit, and rarely applicable. The basic premise is that investors should expose themselves to less investment risk as they age. This is true in some cases, but not all.
Bonds are a stable asset most of the time. Normally, the return of a bond is based on the interest payment of the bond. But here’s the problem, over the last 35 years, bonds have had incredible capital appreciation as well, or growth of the value of the bonds not including interest payments. This is normal in a low interest rate environment, in which the value of existing bonds increases.
Presently, hindsight is very important, as we are very close to interest rates bottoming out. If interest rates cannot fall any lower, the risk of either flat or rising interest rates increases greatly. Although rising interest rates hurt bond prices in the short term, as issuers create higher interest bearing bonds, it can be helpful in the long run. On the other hand, if interest rates stay flat, bond prices are most likely going to change only with a change in default risk, and usually for the worse.
Let me explain why the rule is incorrect. Take a 50-year-old, retiring in 17 years, at the age of 67. The rule states that she should have 50% of her portfolio in bonds. I disagree that half of her assets should be earning little or nothing. To take it a step further, a 70-year-old should have 70% of their portfolio in bonds? If the average life expectancy was 65, this would make sense. However, the 70-something retiree is expected to live at least another decade, if not two. With 70% of her portfolio earning very little, running out of money becomes a very real possibility.
So, what should be the rule of thumb? Each person’s risk threshold is different regarding their investments. Having an allocation appropriate to one’s risk tolerance is a more effective way of deciding what percentage of a portfolio should be in bonds.
Taking this approach makes my work immensely enjoyable!
Are you a risky investor? Self-professed risky investor? In my experience, so-called risky investors, often panic when a major market decline occurs and are scared to death of further loss. I protect you from selling low.
Consider yourself conservative? I often find investors who profess a conservative mentality, yet don’t mind the ups and downs of the market no matter how bad the economy is. I will help you seize opportunities that, having a false sense of conservatism, would sneak right under your nose.
At Engage Advisors, LLC, we're always happy to break through perception and discover your personal reality.