Stock bond ratio by age – A new take
Everybody knows you need stocks and bonds in your portfolio. The question is. How much of each is right for you.
British Expat Money get asked that all the time. So time for an answer. But here’s the thing.
If this was an exact science, there would be one way to do it. Spoiler alert: There’s more than one way to calculate this ratio.
We’ll go through them one by one.
But before we get into all that, it’s worth just recapping why you need to be investing in stocks and bonds in the first place.
Why you need both stocks and bonds in your portfolio
It’s pretty commonly accepted these days that index funds (or index tracking ETFs) filled with stocks are the just about the best way to grow your wealth for most people. Anybody with a brokerage account can invest.
Yes, property is probably a close second but the work involved means it isn’t going to be suitable for most. (We’ve compared property and index funds here if you are interested).
The headline being this: even city centre serviced apartments let out to professionals require some work on your behalf. Index funds, on the other hand, don’t.
The consensus also agrees that your index funds should contain lots of stocks rather a few choice individual picks and some bonds.
Investing in one stock is risky. It could go to zero. Investing in thousands of stocks not so much. Some of them may go to zero but the big winners will more than make up for the losers. After all, a stock can only loose 100% of its value whereas it’s potential to grow is infinite. The stock prices of really big winners like Amazon have grown thousands of percent.
Heavy lifting
Stocks do the heavy lifting in terms of investment returns, but you need bonds to even out the ride. Stock markets do have a nasty habit of crashing from time to time. 10% drops occur almost annually. 20% drops are a regular occurrence and all investors should expect to see a 40-50% drop at least once in their life time.
Though, historically, stocks have always recovered to reach new highs that doesn’t stop people panicking and selling all their stocks after they’ve dropped.
And the thing is that is exactly the time they should be buying more!
Easier said than done though. When the value of your stocks is dropping like a stone, the last thing most people want to do is buy more.
The tried and tested method to getting around this conundrum is having some bonds in your investment portfolio. Bonds don’t give you the kind of returns you get from stocks, but they do usually give you more than you’d get in a savings account.
The more bonds you have, the less your portfolio should go down when stocks crash and as an added bonus you can sell some of them to raise funds to buy cheap stocks.
Essentially, you allocate a percentage of your money to stocks and a percentage to bonds and maintain this allocation throughout your investment time horizon.
And that’s where your stock bond ratio by age comes into play.
Stock bond ratio
Changing your ratio of stocks to bonds according to your age is a method usually associated with Jack Bogle, the founder of Vanguard and the guy that made index funds a thing.
And it’s as straightforward a solution as you are likely to get. Quite simply, your age determines the amount of money you have in bonds, leaving the rest in stocks.
So for example, if you are 40, you have 40% of your money invested in bonds leaving the remainder (60%) to be invested in stocks.
In other words, if you had £100K to invest. £40K would be invested in bonds and £60K in stocks.
And by the way, you’d call that a 60/40 portfolio.
Which brings us nicely to the next point. You don’t have to do too much reading about investment to come across a 60/40 portfolio. Many people invest that way no matter how old they are. We’ll come to other ways of allocating between stocks and bonds later.
But for now just know there are other ways to determine your stock and bond allocation and even other ways to determine your stock bond ratio by age.
Jack of all trades
And the first of these comes again from Jack Bogle.
In one of his many great books, Common Sense on Mutual Funds he offers a slightly different approach.
What percentage of your investment portfolio should be in bonds ranges from 20-50% and depends on four characteristics. Whether you are older or younger and in the accumulating or distributing stage of your investment timeline.
Of course, probably not wanting to offend anyone, Bogle leaves it up to you to decide the age bit and we’ll talk a bit more about that below but if you are still saving you’re in the accumulating stage, and if you are spending you are in the distributing stage.
The Bogle Method
| Age | Accumulation | Distribution |
| Older | 30% bonds | 50% bonds |
| Younger | 20% bonds | 40% bonds |
The remainder of your funds would be invested in stocks.
The new method
Alternatively, there’s an update to Bogle’s first method we talked about.
It’s pretty similar, but takes into account the fact we can now expect to live longer and the idea that we should be investing for longer than we think (another point we are going to look at in a bit more detail later on).
Rather than simply using your age to determine your bond allocation, you instead subtract your age from 120, using the number you are left with to determine how much of your balance should be in stocks.
So if you are 40 that’s 80% in stocks and 20% bonds. In other words, an 80/20 portfolio and a portfolio that has a lot more of your money allocated to stocks than if you had simply used your age.
One things for sure, it is definitely a more aggressive approach. One that some investors might describe as very aggressive indeed.
Psycho
In theory, this sounds like a sensible approach. But practice is a different kettle of fish.
This approach fails to take into account the psychology of investing in stocks. In case you haven’t heard, it’s pretty simple. When stocks go down people panic. When stocks go down big time people panic big time.
The damaged caused by selling out in a crash isn’t worth it.
How do you know if you will panic sell in a crash? Simple. You live through one. If you were fully invested in stocks when the market crashes 50% you’ll know how you’ll behave forever afterwards.
If you’ve already done it, and it was like water off a ducks back to you and you didn’t panic sell then great. Keep things as is. On the other hand, if you’ve never lived through a crash you don’t know how much of a panic merchant you are.
And if that’s the case, its best to avoid the risk. Whatever amount seems sensible to you, turn it down a notch or two.
Investment by aggression
Conservative investors should feel a little better having less of their money in stocks when the markets crash.
The table below is a useful guide. It’s mix between the two methods we’ve already touched on.
Very conservative (the original method) right the way up to very aggressive (the newer method).
We like to call it the aggression method.
The aggression method
| Age | Very Conservative (% stocks) | Conservative (% stocks) | Moderate (% stocks) | Aggressive (% stocks) | Very Aggressive (% stocks) |
| 20 | 60 | 70 | 80 | 90 | 100 |
| 25 | 55 | 65 | 75 | 85 | 95 |
| 30 | 50 | 60 | 70 | 80 | 90 |
| 35 | 45 | 55 | 65 | 75 | 85 |
| 40 | 40 | 50 | 60 | 70 | 80 |
| 45 | 35 | 45 | 55 | 65 | 75 |
| 50 | 30 | 40 | 50 | 60 | 70 |
| 55 | 25 | 35 | 45 | 55 | 65 |
| 60 | 20 | 30 | 40 | 50 | 60 |
| 65 | 15 | 25 | 35 | 45 | 55 |
| 70 | 10 | 20 | 30 | 40 | 50 |
| 75 | 5 | 15 | 25 | 35 | 45 |
| 80 | 0 | 10 | 20 | 30 | 40 |
| 85 | 0 | 5 | 15 | 25 | 35 |
| 90 | 0 | 0 | 10 | 20 | 30 |
| 95 | 0 | 0 | 5 | 15 | 25 |
| 100 | 0 | 0 | 0 | 10 | 20 |
Essentially, the table takes a simple concept and expands upon it depending on what kind of investor you are.
Of course that’s all very well if you know what kind of investor you are. Otherwise not so much, but don’t worry, we are coming to this too.
But which is the best way?
So, we’ve already covered four methods for determining your stock bond ratio based on age.
- Age = Bonds
- The Bogle Method
- 80 – Age = Stocks
- Aggression Method
All of which have merit. Whist one and three are simple, I don’t think they cut the mustard really. At the end of the day, allocating between stocks and bonds is one of the most important investment decisions you are ever going to make.
Considering what kind of investor you are is probably going to be pretty important for your long term success, meaning 2 and 4 are looking a bit more robust.
Think about it this way. Going very aggressive when you are 20 only to panic sell your stocks when the stock market halves during the next crash could put you off investing for life.
Investing is about staying in the game and compounding gently over the very long term.
And if you are the kind of guy to panic sell having 80% of your allocation in stocks aged 40 probably isn’t going to be much better.
Which does beg the question, ‘is there another way?’
And spoiler alert, there just might be.
Why traditional methods might not make sense
We’ve already established that people of different ages might suit different amounts of stocks and bonds in their portfolio depending on how conservative or aggressive they want to be with their investments, but that’s not the whole story.
These days you’ve got people investing for all kinds of different reasons. Maybe you are saving for your kids university fees or perhaps a new house. Maybe, you are intending to retire early.
In any of these cases, using age to determine your stock bond ratio isn’t going to work. It’s practically meaningless.
It isn’t a stupid idea. It’s on the right lines. It just doesn’t quite get us where we need to be.
No, what we really need to be looking at is ‘age’s’ distant relative, ‘time horizon.’
You need to ask yourself. How long do you plan on investing for?
Whilst one 50 year old investing for retirement may be looking at a 30 year time horizon, a 40 year old couple investing for their children’s university fees may be looking at half that. And a 20 year old investing for a deposit on new home may only be looking at half that again.
In other words, it’s about how long you will be investing for, not how old you are. Time horizon is key.
Why your time horizon is probably longer than you think
At a basic level, the concept of time horizon in investing is a simple one to grasp. The longer it is the more stocks you have in your portfolio.
However, many people underestimate the actual length they will be investing for their retirement.
The key mistake is thinking the minute you retire you stop investing. That’s not the case!
Pension calculations assume you will invest throughout your retirement. Generally, they assume you withdraw an inflation adjusted percentage of your pension pot throughout retirement. The inflation adjusted bit of this relies on the fact you are invested. If you leave your money in cash there’s a good chance the calculations won’t work and worse still that you will run out of money.
You should plan to invest throughout your retirement, which for most people means until they are in their mid eighties, but depending on how young you are you might increase that to your 90s or beyond.
Once you establish your time horizon, the simplest way to determine your stock and bond mix is probably to use the 4% rule.
I’m going to call this ‘the other 4% rule.’
Bringing time horizon into the mix
The ‘other’ refers to the fact that there is another 4% rule out there, which to be honest, is more widely known than this one. That one covers withdrawal rates for retirement planning.
So just to be clear we aren’t talking about that one. We are talking about the ‘4% rule’ for allocating between stocks and bonds.
And whilst that intro might be a bit confusing, the concept itself should be pretty easy to grasp.
Quite simply, you invest 4% of your money in stocks for every year you plan to invest, leaving the rest of your money in bonds.
Investing for 1 year? That’s 4% of your money in stocks. 10 years? That’s 40% in stocks.
Cautious investor? Change that number to 3 and you are good to go. You can see how those numbers pan out below:
The 4% rule
| Age | Years until 85 | Conservative % stocks | Normal % stocks |
| 20 | 65 | 100 | 100 |
| 25 | 60 | 100 | 100 |
| 30 | 55 | 100 | 100 |
| 35 | 50 | 100 | 100 |
| 40 | 45 | 100 | 100 |
| 45 | 40 | 100 | 100 |
| 50 | 35 | 100 | 100 |
| 55 | 30 | 90 | 100 |
| 60 | 25 | 75 | 100 |
| 65 | 20 | 60 | 80 |
| 70 | 15 | 45 | 60 |
| 75 | 10 | 30 | 40 |
| 80 | 5 | 15 | 20 |
| 85 | 0 | 0 | 0 |
Those numbers couldn’t be further away from the old ‘age in bonds’ method we considered at the beginning.
If you are 40 you’d have 40% of your money in bonds using the original approach, whereas assuming you expect to live until 85, using the 4% for every year you plan to invest method you’d have 100% of your money in stocks.
In fact, even if you replace that 4% with 3% because you are a conservative investor, you’d still have 100% in stocks.
That’s a big difference. In fact, it’s too big a difference to be confident in either approach as far as I am concerned.
Are still no closer to answering the question we ran in to before. Namely, ‘what kind of investor are you?’
What kind of investor are you?
Which brings us nicely on to the final method of determining your mix that we are going to look at.
And spoiler alter, I think this one’s by far the best.
It comes from esteemed financial guru, Larry Swedroe’s book, The Only Guide You’ll Ever Need for the Right Financial Plan.
Swedroe also sees things in terms of time horizon. In fact, he agrees the longer your time horizon the more stocks you should have in your portfolio just like the 4% rule. Check out the table below:
The Swedroe method
| Your investment horizon (years) | Maximum stock allocation |
| 0-3 | 0% |
| 4 | 10% |
| 5 | 20% |
| 6 | 30% |
| 7 | 40% |
| 8 | 50% |
| 9 | 60% |
| 10 | 70% |
| 11-14 | 80% |
| 15-19 | 90% |
| 20 and above | 100% |
Though not exactly the same, it’s not too dissimilar from the 4% rule, but it’s worth having a long hard look at those numbers.
That’s because most people investing for retirement should have a time horizon of at least 20 years.
We’ve already established most people should be investing until they are 85-90ish.
Assuming 85, according to those numbers, anybody up to the age of 65 should have 100% stocks in their portfolio.
And again, that is a little bit aggressive. No, it’s aggressive with bells on. It’s going to be way too much for most investors.
It would only suitable for an investor with an iron stomach who isn’t afraid of stock markets getting smashed to smithereens.
And thankfully it seems Swedroe knows this only too well because he adds an additional step to his approach.
You need to think about what kind of investor you are.
More specifically, you need to think about the maximum amount of loss you think you would be able to tolerate.
Your toleration for loss
| Maximum loss you’ll tolerate | Maximum stock allocation |
| 5% | 20% |
| 10% | 30% |
| 15% | 40% |
| 20% | 50% |
| 25% | 60% |
| 30% | 70% |
| 35% | 80% |
| 40% | 90% |
| 50% | 100% |
And now I think we are really starting to get somewhere.
Taking both tables together really starts to put things in perspective.
As an example, I think I’m going to be investing for 25 years so I according to Swedroe’s Time Horizon table I could have 100% stocks.
However, I’m pretty sure I couldn’t handle a 50% drop in my wealth no matter how temporary it was. In fact, I don’t think I could handle anymore than a 30% drop, so looking at the table above 70% in stocks is going to be my limit.
And I think this works even better if you use real money when you begin number crunching.
Aiming for £500K in your portfolio? Could you really stomach your balance dropping £100K? If not you better have at least 50% of your portfolio in bonds.
I think for most people, Swedroe’s approach will get them a much better idea of how their portfolio should be split between stocks and bonds than simply looking at age.
And by the way Swedroe isn’t done yet. He also points out that you should consider your need to take on risk in the first place. If you don’t need to take on risk why bother! You are just being greedy if you invest in stocks when you don’t have to.
There is simply no point risking your money if you don’t need to. If you are saving enough so that you’ll have enough in retirement without investing in stocks it maybe good idea not to bother.
On the other side of the coin, if you need a certain amount in retirement and a savings account isn’t going to get you there, perhaps you need to take on more risk.
The bottom line
So there you have it. There’s more than one way to determine your stock and bond ratio.
A better alternative to the traditional methods for most people is going to be to consider time horizon rather than age.
But even that won’t work perfectly on its own unless you consider what kind of investor you are.
British Expat Money think the Larry Swedroe approach where you consider time horizon alongside the losses you are willing to take is going to be a better approach for most investors.
And by the way, if I was only going to use one table it would be one that considers the losses you are willing to take.
