The Classic Investing Rule That Most Investors Should Ignore
Long-time investment experts live by many investing rules of thumb, but sometimes those old rules go by the wayside. One such rule of thumb tells investors that their investments should include a percentage of bonds corresponding to their age. For example, if you are 25 years old, 25 percent of your portfolio should be made up of bonds. Does this rule make sense today? Probably not. Let’s take a look at why this investing rule of thumb has gone out of style.
Breaking Down the Bond Percentage Rule of Thumb
Before we start bashing an old investment adage, let’s take a look at what the rule means and why it made sense in the past. As we briefly mentioned above, this rule of thumb states that your percentage of bonds should match your age.
The idea behind this theory is sound. Bonds are considered more stable and less risky than stocks, and the rule suggests that your portfolio should become more and more heavy with bonds as you age and get closer to retirement. This is absolutely true. In most cases, you are best off adding more bonds to your portfolio as you near retirement. If you invest in a target date mutual fund, your investment is managed with this in mind, and your investment in the fund slowly shifts from stocks to bonds over time.
With this in mind, what is wrong with the rule? The timing no longer makes sense. We are living longer than ever, and moving into lower yield investments at a young age makes less and less sense.
Someone in their mid 20s should have some bonds in their portfolio, but that percentage should be far less than a quarter of their assets. The same is true in your 30s, 40s, and 50s.
Even at 50 years old, most people plan to work at least 15-20 more years before calling it quits. The current average retirement age in the US is 63 years old, but that can vary based on location and financial need.
With over a decade before you need to start cashing in those investments for retirement, should they be at least 50 percent in bonds? Again, probably not.
You Should Own Fewer Bonds and More Stocks Until You Near Retirement
Because we are living longer, you should avoid owning too many bonds while you are still young and working. When you have less than a decade left before retirement, that is the time to get more aggressive about putting bonds in your portfolio. Before that, you may be costing yourself big on investment returns.
One of the most popular bond funds is the Vanguard Total Bond Market Index Fund (VBMFX). Average annual performance in this fund overs around 2 percent to 4 percent over the last ten years. The stock focused Vanguard 500 Index Fund (VFINX), on the other hand, returned around 9 percent to 14 percent over the same period. A bond heavy investor would have lost out big over the same time horizon. While stocks are riskier, they tend to perform better over a long-time horizon than bonds.
Create Your Own Bond-Stock Mix to Match Your Goals
As you reach your sixties and beyond, you have a much shorter timeline before you will need to tap your investments. By the time you near your golden years, you don’t necessarily have a decade or so to recover from a market downturn.
This is the timeframe when you should invest heavily in bonds.
But as a young investor with ten years or more before you plan to retire, there is no reason to put too much into bonds. Particularly for younger investors in their 20s, 30s, and 40s, this rule of thumb should go down in the history books, not your current investment playbook.
Everyone’s investment goals are different, and everyone has a different level of risk tolerance. Finding the sweet spot where your risk tolerance and goals meet will help you decide what percent of your portfolio belongs in the bond market. For most investors still working a full-time job, that number will be far lower than your age.