Whether you’re a recent college grad, mid-career professional or senior, deciding how much to put in stocks and bonds can be confusing.
Some people base their decision to go with one or the other on risk tolerance – comfort with big market wiggles – and little else. Some follow rules of thumb like “Subtract your age from 100, put the difference in stocks and the rest in bonds.” Easy rule, but wrongheaded.
So unless you consider your goals, you’re aiming without a target – and that means you’re likely to miss.
A huge factor that is usually poorly considered when people split their investments between stocks and bonds is time horizon – which is basically how long your savings must provide for you.
Many confuse it with retirement, when you shift from socking money away to taking it out. Others realize their time horizon is their whole life, but forget to consider younger spouses or heirs. If Jim is 60 and married to 50-year-old Judy, his time horizon is really hers, and it’s likely 35 years or longer.
Lengthen time horizon
Whatever your situation, your savings likely must last a long while – at least for your own lifetime, which is probably longer than you think! If you’re retiring now, for example, odds are you’ll see your mid-80s at least. Younger folks have a high chance of passing 90.
My advice is to tack several years onto whatever your personal life estimate is, just in case. Averages aren’t predictive. No one wants to be impoverished late in life because they didn’t think they would be here.
Set your big goals
Then, discern your main goals. Start by jotting down what your retirement money must accomplish for you. Provide for daily needs? Fund some jet-setting? Weddings and college tuition for kids or grandkids? Support late-life medical care?
From my experience watching thousands of clients over decades, these objectives usually add up to one of three big goals: Long-term growth, ongoing cash flow or some combo or the two. Even if your objectives are all cash-flow oriented, you probably still need some growth.
Why? Inflation! Since 1925, inflation has averaged about 3 percent annually, eating purchasing power. That’s annoying.
If it remains at that level in the long run, someone who needs $50,000 for annual living expenses now would need around $90,000 in 20 years and $120,000 in 30 years. If you stashed a cool million bucks under your mattress now, in 30 years it would only have the purchasing power of $400,000 today.
And that’s just an overall average. Total inflation doesn’t measure personal costs of living. Hospital service costs, for example, have jumped 314 percent since 1989. Medical care and drug costs have soared over 150 percent. Your money doesn’t just need to support you longer than you think, it probably needs to be able to purchase much more than you expect.
For most folks, even those who are retired, the solution is some bigger chunk of stocks for far longer than they thought – which is how you get long-term growth. Over long stretches – 20, 30 years or more – stocks usually do far better than other liquid alternatives like bonds. While there are more ups and downs along the way, the long-term growth of stocks can ensure your golden years aren’t pyrite.
Depending on your personal situation, you will eventually need bonds too – not for income, since you will be slowly using your principle, but to help smooth the bumps and support your cash flow.
Most folks I see err most by putting too little in stocks. So when you’re done reading USA TODAY, fire up your account and see if it really matches your needs.