How much should you have in Bonds Vs Stocks?

When it comes to asset allocation between stocks and bonds, nearly every money management book I have read suggests that a person should have a higher percentage of bonds in their portfolio as they grow older, using age as the primary determining factor.

The Bond Vs. Stock rule of thumb

One rule of thumb is that your age should represent the percentage of bonds you have. If you are 20 years old, you should have 20% in bonds. If you are 30 years old, you should have 30% in bonds, and so on.

I think this is ridiculous. These rules of thumb are slowing down the growth potential of a young person right from the early years when they have the ability to take the most risk.

In my opinion, a 20-year-old should not have any part of their portfolio in bonds. Stocks grow at about 8% per year, while bonds grow at about 2% per year. People buy bonds because they want less volatility. However, at 20 years old, the amount of money is not significant, and the young person can withstand all kinds of volatility.

Bond Vs. Stock according to the amount of money

People should not be placed into a cookie-cutter formula.

Example 1: Daniel is 55 years old and only has $10,000. Does it make sense to put 55% in bonds? To protect it against what? Considering the cost of living in the US or Canada, $10,000 would not take him far. Daniel will need to find a lot more capital if he wants to retire or he will have to work well past his retirement years. The bond vs. stock allocation is irrelevant for him. If I were him, I would put 100% in stocks. He doesn’t have much to lose, so why not take a chance?

Example 2: Maria has a portfolio of $10,000,000. Maria could be 100% in bonds no matter what age she is. Why would she take any risk at all? At today’s (2024) bond yields of 5%, Maria would receive $500,000 every year. Age is not a factor when we consider Maria’s asset allocation.

Example 3: Louis is 65 years old with a portfolio of $500,000. He also has a fixed pension that provides enough money to live on. Louis could have a portfolio of 100% stocks. No matter what risk he takes, he is covered. If he lives to 85 years, his money has 20 more years to grow. His kids and grandkids will be very happy.

Example 4: Carla is 75 years old with a portfolio of $1,000,000, and her living expenses are only $50,000 per year. She wants to leave whatever money is left to her 50-year-old daughter and 25-year-old grandson. It’s the same money, but the beneficiaries are of three different ages. How do you square that hole? Should the money be invested with Carla, her daughter, or her grandson in mind?

As you can see from these examples, age is not the most important factor. The amount of money is the most important factor.

Where do you fit in? What are your special circumstances? How much money do you have to support the life you want to live? How much money do you want to leave behind?

Bonds are not safer than stocks

You hear it all the time: “Bonds are safer than stocks.”

That’s simply not true. Bonds are less volatile than stocks, but they are certainly not less risky. Here is a chart of the stock market returns for any 20 year time period. If you notice, the S&P has never lost money in any 20 years time period. Yes, there is a lot more volatility when you are 100% in stocks, but over any 20 years period, the risk of loss has been 0%.

How I would allocate my money

This is quite personal, so don’t apply it to your life unless your life is similar to mine and you have similar objectives.

My lifestyle is very frugal. I live on less than $24,000 per year ($2,000 per month). I don’t deprive myself, it’s just that I don’t own a car, I eat out at small neighborhood restaurants, and I don’t care about fashion.

One way to figure out how much I need to live is by applying the rule of 4. I divide my annual expenses by 4%. I get $600,000. So, if $600,000 is my number, I would put in bonds any amount over $600,000. If the market drops, I would transfer money from my bond holdings to stocks.

As it is right now, I am 57 years old. I have over $500,000 in my broker’s account, 100% in stocks. If I live another 43 years (until age 100), and if I assume that the market will give me a 6% rate of return, I can spend about $3,500 per month for the rest of my life. So yes, I feel confident that the market will give me over a 6% average return over the next 43 years. I feel good about my retirement plans. And I am not counting any income from a pension plan or any additional income I might earn from now until death.

If you want to find out how much spending you have in your life, you can use a financial calculator like this one.
Solve for payment (PMT)
Put the amount of years you think you will live N
Guess the rate of return you think you will get I/Y. The average return on you investment you think you can get. Over the past 10 years the average return of the S&P 500 has been over 10%, the 100 year return of the S&P has been over 8%. Because I am conservative, I am putting 6%.
Put the amount of money you have PV
If you are planning to die with zero, in FV write -$0. If you are planning to leave a money inheritance to someone, write that amount in a negative number.

And there you have it, the amount of money you can spend for the rest of your life. Add to this the amount of money you will receive from any government or corporate pension plan.

A question for you

Will you use age or the amount of money as a determining factor for your bond allocation?

What would be the trigger point to switch from stocks to bonds? At what age? How much money?

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