Why Your Portfolio Needs Plenty of Stocks, Whatever Your Age
By DAVID A. LEVINE
FEB. 5, 2016
WHEN I went to work on Wall Street in 1972, it was an article of faith that older investors should own less common stock than young ones. One rule of thumb suggested that your equity exposure should equal 100 percent minus your age: 70 percent for a 30-year-old, for example, but just 35 percent for someone who is 65.
Since then, investment practices have evolved considerably, but on the question of how much common stock to own — the single most important question governing investment returns — not much has changed.
Typical recommendations nowadays propose greater equity exposure than they did 40 years ago, but it is still the overwhelming view among investment counselors that people should reduce their holdings of common stock and beef up their ownership of bonds as they grow older.
Problem is, it wasn't very good advice back then, and it's still poor advice today.
I know this opinion puts me in the minority, but if you are a retiree or nearing retirement, you should hear me out.
Let's begin with the standard view today.
Customer representatives at Vanguard, one of the largest investment managers in the world, generally refrain from offering unsolicited financial advice. Still, when you log in to your account at Vanguard, you will see two pie charts. One shows your current asset allocation and one shows what Vanguard's algorithm (based solely on your age) thinks that allocation should be. Something similar is suggested by most other investment firms and financial advisers.
If you happen to be like my daughter or son — both in their mid-30s — Vanguard will propose a target asset allocation that is 90 percent stocks and 10 percent bonds. For a 69-year-old like me, however, the default suggestion is 45 percent stocks and 55 percent bonds. Vanguard offers a disclaimer noting that it has not taken "personal circumstances" into consideration.
Assuming all of us followed the preferred allocation, our family's financial assets would collectively be less than 50 percent equities because my wife and I have a lot more money than our children. But if we died in a plane crash tomorrow, and the children inherited our money, the recommendation for how to allocate those same assets would shoot up to 90 percent stocks.
Investing Forever
Most financial advisers recommend that investors gradually reduce their stock holdings as they age to limit the volatility of their portfolio. Vanguard's target date funds reflect the consensus view, but Vanguard's own customers seem to favor not dropping their equity exposure so much.
Isn't that a little strange?
I'm not picking on Vanguard; I hold most of my investments in Vanguard index funds and their recommendations mirror what the rest of the industry preaches. Indeed, the "target-date funds" of Vanguard, Fidelity, BlackRock and the Capital Group all allocate 84 to 97 percent stocks for people who plan to retire in 2045 versus 52 to 61 percent for those planning to retire in 2020.
I asked Maria Bruno, a senior analyst specializing in retirement-related strategies for Vanguard, to explain the reasoning behind those allocations. "As you age and your time horizon shortens, you need to diversify by increasing your exposure to bonds," she said. "This will help mitigate the short-term volatility of your portfolio that derives mainly from the equity component."
This consensus view, though, rests on a fallacy: the belief that as people grow older, their investment horizon shortens and, therefore, their ability to withstand volatility diminishes considerably.
I would argue, instead, that there is an insufficient appreciation of just how apt the metaphor of the "investment horizon" is. Just as a sailor sees but never reaches the horizon, the same is true for nearly all investors.
A just-retired 66-year-old might expect that her assets will need to support her for a further life expectancy of only 20 to 21 years. But what happens if she treats that actuarial expectation as a certainty, spends too much each year, and ends up healthy and vigorous at age 87 with no assets left?
At 87, the average woman can expect to live another six to seven years — a healthy woman, even longer. And she might get "unlucky" and live to be 100, in which case her assets will need to support a retirement of 34 years.
The prudent course for any retiree is to plan on a longer-than-normal life. Retirees typically liquidate only a small portion of their assets every year. Accordingly, the mere act of retiring should not prompt any change in your exposure to the financial asset — common stock — that is almost certain to produce the highest returns over the long run.
But what if there's a bear market? "No big deal," I say. As long as you don't panic and sell most of your holdings at the worst times, your annual withdrawals are limited. As a result, you should not really worry about fluctuations in the stock market.
Not worry about the volatility of the market? True enough, sometimes you'll be selling when the stock market is depressed, but at other times you'll be selling when the stock market is elevated.
On average, you'll be liquidating your positions at average prices and, over time, you will earn the average performance of the stock market. And the long-established truth is that a diversified collection of stocks, over most any reasonable time period, will outperform the average performance of bonds.
But what happens when our healthy, vigorous retiree gets to be 99? Surely there is not much time left. That is true: She is fast approaching her personal horizon. But her assets have not reached their horizon. They will be bequeathed to her children, or other relatives and friends, perhaps a few favorite charities — extending the horizon anew.
I can count on one hand the number of people who have said to me that they don't care about any relatives, friends or charities and that it is their intention to spend all of their money — ideally running the balance down to zero — on the day they die.
It is the realization that the investment horizon is long and that it is continuously receding that leads us in the direction of a correct asset allocation. And that means we should not reduce exposure to the stock market as we age.
But what is the correct allocation between stocks and bonds? My answer to that question will come next week.
David A. Levine is a former chief economist at Sanford C. Bernstein & Company, now a unit of AllianceBernstein, who also founded and ran the firm's fixed-income department.
Posted by: sarah_oz@yahoo.com
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