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Financial planning not based on age alone

Gail MarksJarvis

November 2, 2012

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Q: We are age 79 and 76, retired, in good health, and are fortunate to have enough money to live out long lives and probably leave an estate to our children. I would like to know what is a decent asset allocation for somebody in our financial situation. Naturally, we would like to preserve our principal. We've been told that 100 minus age (79) is the amount that should be allocated to equities, but we've also been told by an adviser that 60-40 is proper. Why would we be getting advice that differs so greatly?

— K. G.

A: People often think that there is one right mixture of stocks and bonds based on a person's age. But there is more to the answer than age alone, and that might be why two different advisers have very different recommendations for you.

Often, for people late in their 70s, advisers will suggest investing just 20 to 30 percent of a person's nest egg in the stock market. In other words, they apply the simple rule of thumb that you mentioned. That rule of thumb: subtract your age from 100 to determine how much you should invest in the stock market.

That rule of thumb can be applied to people of various ages. So a 79-year-old would put 21 percent of their nest egg in stocks, and the rest in bonds. Thirty-year-olds with 401(k)s would subtract their age from 100, and put 70 percent of their money in stock mutual funds and 30 percent in bond mutual funds.

The idea is that the closer you get to retirement, or when you are actually retired, you reduce the risk of investing much in stocks because stocks can turn volatile when you can't afford a loss as a retiree. Yet advisers often urge retirees — even in the late 70s — to have a little money invested in stocks if the people can stomach a horrible market and wait for the healing phase that inevitably will arrive.

Of course, if you lived through the last decade, you know that there are times when stocks can sink 50 percent and fail to recover for a full 10 years. So even putting 20 percent in stocks would be a mistake if you worry about losing money.

You need an even stronger stomach if you are going to invest 60 percent of your money in stocks and 40 percent in bonds. The more you have in stocks the worse your losses will be in a downturn. For example, if you had invested $10,000 in a 60-40 mixture of stocks (the Standard & Poor's 500 index) and long-term U.S. Treasury bonds just before the financial crisis in 2007, you would have lost 29 percent from the peak in the stock market to the worst point in early 2009. In other words, if you had invested $10,000 at the peak, you would have had just $7,140 left at the ugliest point. Still, three years later you would have had about $12,340 and perhaps wondered why you were so panicked at the worst point.

If you were panicked and insisted on cashing out after the plunge in the market in 2007 to early 2009, you should never consider a 60-40 mixture of stocks and bonds — no matter what your age and no matter how sure you are that stocks will keep climbing. You don't have the emotional makeup to wait for the upturn in the market.

But that's not all there is to the question. If you are retired and can invest more conservatively, and earn enough income on safe bonds like U.S. Treasury bonds, state general obligation bonds and CDs to keep up the lifestyle throughout your lifetime, there is no reason to subject your nerves, or your nest egg, to the risks of the stock market.

If you had invested just 30 percent of your $10,000 in the U.S. stock market and the rest in long-term Treasury bonds just before the financial crisis, you might have been much more relaxed than with the 60-40 mixture. You would have lost just 3 percent, and in less than a year you would have been making money again. Three years later you would have had about $14,100.

So does that mean the adviser suggesting a 60-40 mixture to you is way off the mark? Not necessarily. The adviser might be basing the recommendation on the fact that you expect to have an estate worth about $5 million that you never plan to touch.

Some advisers have clients imagine putting their money in different buckets. There may be the bucket of money allocated for your future, which is invested much more conservatively than 60-40 because you are retired and living off the income from investments. And then there may be money in your children's bucket — perhaps invested 60-40 so stocks help the money grow.

gmarksjarvis@tribune.com

gmarksjarvis@tribune.com

twitter @gailmarksjarvis