How Should I Allocate My Assets?
What is your current asset allocation to stocks and bonds? There’s a good chance that it’s 60% in stocks and 40% in bonds because individual retirement account (IRAs) and near-dated target date funds (TDFs) have this allocation. This “60/40 Standard” has been in place for more than 50 years. It derives from research showing that 60/40 provides the “best” return for the level of risk.
According to EBRI (the Employee Benefit Research Institute), the average asset allocation in IRAs is 60/40 for all ages. And according to Morningstar, the average TDF is 60/40 near its target date.
But Bank of America, Forbes and others have declared that the 60/40 rule is dead.
The problem of course with pat rules like this is that one-size-fits-all ignores your individual needs and circumstances. We all need and want different risk at different times in our lives, and we want to be rewarded as much as possible for taking that risk. It’s absurd to think that 60/40, or any other pat answer, can be right for everybody all the time.
In fact, there’s a time in most people’s lives when 60/40 is way too risky. There is a “Risk Zone” spanning the 5-10 years before and after retirement when losses can devastate lifestyles and shorten the time that savings last, even if markets recover. Unfortunately, 60/40 is the mix in the Risk Zone for most TDFs, but this is just plain wrong. TDFs for people retiring in or near 2010 lost 30% in 2008, and they’ve become riskier since. A prudent TDF should be no more than 20% in stocks in the Risk Zone with the balance in short term Treasury Bills rather than long term bonds. See Don’t Ruin a Happy Retirement.
The success of TDFs has awakened investors to the fact that age matters, and that your risk capacity is at its lowest as you transition from working life to retirement, yet even TDFs are criticized for being one-size-fits-all. The extreme in one-size-fits-all is “60/40 for everyone.”
The moral is straightforward. Do not use the 60/40 rule, or any other pat allocation, in your IRA, or anywhere else, because getting asset allocation right is not that simple, and it’s important to get it right. If your investment advisor tells you otherwise, you need a better advisor.
Because it explains 100% of your investment results, asset allocation is the most important decision you make, and it should not be sloughed off to a simple rule.