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November 09, 2006


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That does seem a bit more aggressive when compared to some other schools of thought, but I do think the calculation is leaning more towards what we will begin to see. The reason is, people are living longer, and retirement for many people reaching that age in the next few decades won't be simply quitting their job and relying on what they have saved to last from 65 until they die. So I think this calculation is more or less addressing that fact to some extent.

Also, which isn't mentioned in the vague calculation is the fact that there is a variety of categories of "stock". Someone could hold a very stock heavy portfolio, yet it could be very conservative. Take equity income funds for example. They are primarily invested in stocks, yet they focus on generating income from dividends. Sometimes these can have yields of 3-6%. So while the underlying securities can be volatile, they are still generating income through dividends, making the actual stock portion of the portfolio perform much more conservatively than say all growth or all value, or even just a blend fund.

So someone who is 60 should probably be close to a 50/50 mix so long as they adjust their equity holdings to primarily consist of high-quality companies that provide dividends. That would allow a good mix between fixed income that is likely to produce returns of 4-7% on average, and have a conservative mix of stocks that also produce income with 2-6% yields, and some possibility for capital appreciation.

The biggest problem is when people who do approach retirement, say 60-65 and they go nearly 90% fixed income, where it is likely to just keep up with or barely outpace inflation. That strategy won't work if they need to stretch this income out over another 30 years.

On the surface, I agree that the 120 - age seems a bit aggressive, but when you look at the strategy you should actually put in place after using that guideline, you should find yourself pretty close to an appropriate allocation.

I rule I have seen is you should invest your age in bonds. So I am 46. I would have 46% investments in Bonds and 54% in stock.

At 65 I would be 65% in bonds and 35% in stocks.

What type of Bonds and stocks would be up to you.


These days when you can earn 5% returns from a no risk online bank account, there is no need to have this much in the stock market.

The only drawback is that the 5% is not taxed a the capital gains rate of 15%

Rob, "these days" don't last. Fixed rates such as savings accounts, CDs, etc. are always changing. While cash is an attractive option right now, it hasn't always been that way, and it won't always be that way. As few as 5 years ago you were lucky if you had a savings account that earned 1%, even 3-year CD rates were averaging around 1.75%.

This is why you need to have a diversified portfolio. You can adjust it year to year as trends change to take advantage, but just because cash rates are high right now should not be a blanket statement to say you shouldn't have that much in stocks is inappropriate, because rates will change in the future, and someone over-exposed to cash/fixed investments will end up losing money after taxes and inflation when rates begin to go down.

Stocks for the Long Run, J. Siegel, points out the optimal investment portfolio over time has been over 100% stocks, that is, you should actually leverage your portfolio and buy more. That is riskier than I would recommend, but not by much. Real returns on stocks run ~7% while for bonds we can only expect what they currently are delivering 2-3%. That difference is too large to turn down. There is a world of difference between stocks and I avoid the riskiest but I would prefer equity-income stocks to bonds.

The approach I start with is perpetual investing, planning to live off a safe rate of ~4%. Since I won't tap the capital and plan to let it grow with inflation, there is no need to be highly conservative with it. Over 15-20 years, bonds are riskier than stocks so would only recommend 50% or more bonds if you are consuming your principal.

This makes sense. You should be no more than 50% in bonds at time of retirement which if taken at 65 would mean 65+50-age, or 115-age. With retirement moving up towards 70, 120-age would be right on target.

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