The investment “rule” you should actually ignore

Ever hear this rule of thumb?

  1. The percentage of bonds in your portfolio should approximately equal your age.
  2. Conversely, the percentage of stocks in your portfolio should equal 100 minus your age.

So according to this, uh… dual-rule, a 25-year-old who’s just starting to save should have ¾ of his portfolio in stocks and only a quarter in bonds.

Meanwhile, his 75-year-old grandpa’s portfolio should be structured in exactly the opposite way, and his 50-year-old dad should have equivalent amounts of each.

This idea keeps turning up in investing listicles and beginner’s guides, to which I say: pffffffft! Sure, we all know that rules of thumb are imprecise and should not be viewed as ironclad laws. But this one is frankly garbage.

“But Graham,” you might say, “I’ve never heard this rule, so why mention it in the first place if you don’t want me to use it?” Well, because its shortcomings highlight some much bigger misconceptions that I’m sure you have come across.

Why the “Rule of 100” Must Not Be Trusted

It does not fit your needs ­– The rule assumes you can afford a certain amount of risk with your investments at certain ages. But some of us need higher returns if we hope to stand a chance of having enough money in our later years, while others may have more than enough and would prefer a smoother ride.

REMEMBER: Age does not dictate risk tolerance!

It does not fit your goals – Perhaps you plan to leave an inheritance to your kids or charity. In such a case, being so conservative with your investments may be the wrong move. The Rule of 100 assumes you have no plans for this cash after you have passed, and that is often untrue.

REMEMBER: Investing is not just for retirement!

It oversimplifies risk – The rule assumes that “stocks=risky” and “bonds=safe.” But that is not always true. A bond purchased at the wrong price or at the wrong time could add unintended risk to your portfolio. In fact, the rule is sometimes re-written as 110 or 120 because bonds haven’t been as “safe” lately as they’re supposed to!

REMEMBER: Context matters for evaluating risk!

So… how much of my portfolio should be in bonds?

That is the wrong question, my friend. You should instead ask, “how much risk should I have in my portfolio?” And THAT depends on a variety of factors — your needs, your goals, and your tolerance for the different types of risk.