Understanding Stock Allocation by Age Rules
Written by
Marc Guberti
Edited by
Elizabeth Constantineau
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How much money should you put into stocks? A popular asset allocation by age model invites investors to let their age guide their investments. As the theory goes, younger investors should put more of their money into stocks, while older investors should gradually allocate more of their capital toward bonds. This approach reflects how people’s risk tolerances change as they get older, but a uniform approach may not be right for everyone.
This guide will explore common stock allocation rules and what to consider before constructing your investment portfolio.
The Traditional Stock Allocation Rule
A basic rule of thumb for many investors starts with deducting their age from 100. The traditional stock allocation by age rule suggests that the difference between those numbers is the percentage of capital that should go toward equities. For instance, a 25-year-old investor would put 75% of their funds in stocks and 25% of their funds in bonds.
As you get older, this traditional stock allocation rule requires that an investor puts more of their money into bonds. This shift reflects investors wanting to generate steady cash flow when they retire. Furthermore, older investors have less time to recover from stock market corrections and crashes.
Reasons for Change
This traditional “100 minus your age” model has been around for decades, but not everyone is on board with it anymore. Although it’s not known when the rule was introduced, it existed in the 1950s. Asset allocation by age worked well when the average life expectancy was 68 years in the United States. Now, the average U.S. citizen is expected to reach their 77th birthday.
While bonds offer more security than stocks, equities tend to outperform bonds in the long run. Furthermore, people are delaying retirement due to heightened life expectancies, the cost of living and other factors that make a stock-centered portfolio more attractive than bond investing. If people are still working, bonds don’t make as much sense since interest is treated as ordinary income. You’ll get more favorable tax rates if you receive qualified dividends or realize long-term capital gains.
Current bond yields are another sign that this “100 minus your age” rule needs an update. Rampant inflation in the 1970s and 80s gave investors the opportunity to accumulate bonds with double-digit yields. Now, you can’t find U.S. Treasuries with yields above 5%. The Fed’s interest rate hikes in response to record inflation in 2022 temporarily elevated bond yields, but they’re slowly coming back down.
Low bond yields don’t suggest much of a payoff, especially considering the tax disadvantages. Meanwhile, investors can find dividend stocks with similar yields that can generate meaningful returns. Bonds made a brief comeback in 2022 among mainstream investors, but stocks look firmly in control due to the recent bull rally.
Modern Guidelines
The “100 minus your age” rule worked for many years, but it’s not as viable as before. Some investors now favor asset allocation models by age that are more aggressive, using “110 minus your age” or “120 minus your age,” depending on their risk tolerance. “120 minus your age” requires a higher risk tolerance since more of your cash will go into stocks.
Under the traditional format, a 30-year-old would put 70% of their cash into stocks and the remaining 30% into bonds. Under the “120 minus your age” rule, the same 30-year-old would allocate 90% of their cash into stocks and the remaining 10% into bonds. This type of portfolio can rally much higher during bull markets and put the young investor on a better path to retirement. However, it also exposes the investor to a higher potential downside if the stock market enters a correction.
Real-World Applications
Some brokerage firms offer target retirement funds that automatically adjust their stock and bond holdings as you get closer to retirement, simplifying the process of age-based asset allocation. These funds have target years for retirement, so it’s important to choose a target fund that aligns with when you want to retire.
For instance, the Vanguard Target Retirement 2070 Fund (VSVNX) caters to young investors. It requires a $1,000 minimum investment and has a 30-day SEC yield of 2.15%. The fund currently allocates 89.90% of its capital in stocks and 9.94% of its funds in bonds. The fund will gradually adjust its holdings over time to reflect that older investors tend to have lower risk tolerances. Eventually, VSVNX will consist of more bonds than stocks.
The T. Rowe Price Retirement 2030 Fund (TRRCX) offers an idea of what VSVNX may look like in the future. TRRCX presents itself as an optimal choice for people who may retire within a few years. The fund has over 53% of its assets in stock and 33.69% of its holdings in bonds, with the remaining funds in cash, convertibles and preferred stock. It’s still a strong omission from the traditional “100 minus your age” rule since that rule implies more than half of the TRRCX portfolio should consist of bonds.
Even though these funds mirror a rule that’s closer to “120 minus your age,” they have still underperformed the S&P 500 since their inceptions. TRRCX still endured sharp drops at the very start of the pandemic and in 2022, when the S&P 500 and Nasdaq Composite were also reeling. VSVNX has outperformed TRRCX due to its higher concentration of stocks, but TRRCX may outshine VSVNX and the S&P 500 during a sharp correction.
What To Consider Before Building Your Portfolio
Investors have a lot to think about when they decide which assets and funds to buy. The investments you make now will have a significant impact on your long-term wealth. However, the stock market doesn’t always go up. Not everyone has the time or mindset to withstand sharp corrections when their portfolios lose more than 20% of their value. These are some of the things to keep in mind as you invest:
How Long You Plan on Working
More people are working longer due to the cost of living, but that’s not the only reason. Some people find purpose in their work and don’t see themselves retiring until they cannot physically perform the work. Investors who plan to work for as long as they can may want to put more capital into stocks. Equities tend to outpace fixed-income assets in the long run, and you can set yourself up to have a good nest egg or pass it on to your heirs.
Retirement Goals
Some people want to have a $1 million portfolio by the time they retire. Others can set the benchmark higher based on their current portfolio sizes and how much they contribute each month. Knowing your goal can influence asset allocation based on age and net worth. If you reach your retirement goal of $1 million, it may make more sense to get into defensive assets like bonds so you can preserve your wealth.
Lifestyle Needs
It’s good to ask yourself if you want to maintain your current lifestyle or if you are willing to downsize. Moving into a smaller house will reduce your monthly expenses, making it easier to stretch your funds. However, you may want to put more of your money into stocks now if you want to go on more vacations when you retire.
Risk Tolerance
While stocks usually outperform bonds in the long run, the asset allocation by age and risk tolerance concept is useful for understanding potential losses during market corrections. It makes sense to have a stock-heavy portfolio in your 20s and 30s, but some people may prefer a portfolio that mostly consists of bonds in their 50s and 60s.
Conclusion
Traditional investment strategies have worked for many years, but they continue to receive some modifications along the way. Some people continue to use the “100 minus your age” rule, while others are using the “120 minus your age” rule. However, you’ll also find people in their 50s and 60s who only have equities. Investors should assess their financial situations, long-term goals and path to retirement before deciding how to allocate their funds.
FAQ
Here are the answers to some of the most frequently asked questions about asset allocation.- What is a good asset allocation by age?
- Younger investors should hold mostly stocks, while older investors may benefit from accumulating more bonds. The modern "120 minus your age" rule suggests that a 30-year-old should have 90% of their assets in stocks. This same rule implies that a 70-year-old should only have half of their assets in stocks. It's important to assess your financial situation before deciding how to allocate your capital.
- What is 100 minus age equity allocation?
- This allocation invites investors to subtract their age from 100. The difference reflects how much of your portfolio should go toward equities. For instance, a 25-year-old investor would put 75% of their assets into equities (100-25=75).
- Should a 70-year-old be in the stock market?
- Yes, a 70-year-old should be in the stock market. Stocks can outperform bonds and don't require much maintenance. However, older investors may want to consider buying more bonds than stocks, since they may not have as much time to endure a stock market correction. It's important to assess your finances and how long you plan on working before constructing your portfolio.
- Risk-averse investors can also stick with less risky stocks and ETFs. Not every equity has the volatility and risk of a penny stock.
Data is accurate as of Nov. 13, 2024, and is subject to change.
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