Maximusnd/iStockPhoto / Getty Images
The recommended split between stocks and bonds has taken a battering in recent years, particularly in 2022 as inflation soared, equity markets turned rocky and bonds failed to provide stability.
It got so bad that some observers declared that the traditional 60/40 portfolio – where a 60 per cent allocation to stocks provided long-term growth and a 40 per cent allocation to bonds provided income and stability – was dead.
Even though the drumbeat for more stocks has died down since then, as the bond market found stability over the past couple of years and fixed income yields proved enticing, the question remains.
What is the right asset mix for you, based on age, risk tolerance, savings and income?
The traditional 60/40 split ignores a lot of information about you. Simply subtracting your age from 100 to get your equity allocation is similarly one-dimensional.
James Choi, a finance professor at Yale University, has taken a tailored approach with a recent working paper, co-authored with Canyao Liu and Pengcheng Liu and released through the National Bureau of Economic Research in December.
Be warned! The paper is thoroughly academic.
But the premise is accessible. In determining the right mix of stocks and bonds, it’s important to include future earnings, either through wages or pensions, in addition to age and risk tolerance.
The best part: The paper includes a spreadsheet so that you can make the calculation yourself and tweak your information, along with expected returns, to see how the results will change.
Surprise surprise, a 30-year-old earning $100,000 a year with $50,000 saved up can probably afford a more stock-heavy asset mix than someone who is on the verge of retirement with $1-million in savings.
I played around with the spreadsheet (the link is here) and discovered that I should have a 65 per cent allocation to stocks, which is slightly higher than where I’m sitting currently, assuming both my partner and I retire at 65.
The more money we have saved up, and the higher our pensions, the more conservative the recommendations.
That makes sense. When you have more money, why take unnecessary risks? If I had a billion dollars, I’d probably put my money into GICs. I think the spreadsheet would tell me something similar.
The Wall Street Journal (subscription required), where I first read about Mr. Choi’s paper, included an example to illustrate the point.
A 70-year-old couple with US$1-million in investable assets (that is, house not included) and a medium risk tolerance should have a stock allocation of 38 per cent. That same couple with a high risk tolerance, though, might consider 64 per cent in stocks, according to the example.
Either way, that’s high next to some other popular models, including subtracting your age from 100 – which is why Mr. Choi’s paper adds another argument in favour of holding more stocks than some traditional models suggest.
A few caveats are in order here, though.
For starters, defining your ideal equity exposure and maintaining it is no easy matter.
That’s because equity and bond values are constantly changing, forcing you to rebalance your holdings regularly – or risk having your equity and bond mix miss their targets.
As well, some holdings might not be easily classified. Some investors might consider high-yield bonds to be risky and strongly correlated with stocks, and therefore not appropriate for the bond portion of their portfolio.
Same goes with some preferred shares, where high yields can suggest an equity-like risk.
More importantly, the stock market has been on a ripping tear for the past year, leading to some concerns about over-valuation or even a dangerous bubble. That could encourage some investors to become more conservative with their investments, out of fear of a nasty downturn. Others, though, might be happy riding the momentum.
The easiest solution to many of these concerns is to hold all-in-one exchange-traded funds, or funds of funds, that do the heavy lifting for us.
In Canada, Vanguard launched three versions in 2018.
The Vanguard Balanced ETF Portfolio maintains an approximate 60/40 split between equities (Canadian, U.S., international and emerging markets) and bonds (Canadian, U.S. and international).
The growth fund maintains a 80/20 split in favour of equities. The conservative version favours bonds, with a 40/60 split.
Competing money management firms have introduced similar products, including asset allocation ETFs from Bank of Montreal and BlackRock.
You won’t be able to fine-tune your equity exposure with these funds if you’re aiming for something more specific than, say, 60 per cent equity allocation. But there’s something to be said for one-stop shopping and automatic rebalancing.
Do you aim for an ideal asset mix? Tell me about your approach at dberman@globeandmail.com.
Chart of the day
Today’s financial tool
If you are torn between leasing or financing a vehicle purchase, the Government of Canada has a detailed calculator to help compare the two options. Ideally, you’ll need to fill in many details about both, which could require a bit of digging.
