The mainstay strategy of investing 60% of your portfolio into stocks and another 40% into bonds is not only outmoded, but also does not generate enough income for many people as lifespans have increased.
This strategy of investing for your retirement has become more of a rarity as inflation can easily erode the buying power of investors.
The 60/40 rule was created when bond yields averaged 8% and the stock market 12%, said Bill DeShurko, president of 401 Advisor, a registered investment advisor in Centerville, Ohio.
"The obvious current problem is that while bonds provide crash protection, they are pretty much dead weight in terms of portfolio performance," he said.
Investors must shift their asset allocation strategy as they get closer to retiring, but even if they are Millennials or Gen X-ers, determining their goals ahead of time will mitigate rising costs in health care.
"Asset allocation is dynamic, rather than static and is most effective when customized to the investor's specific goals, time horizon and risk tolerance, said Greg McBride, chief financial analyst for Bankrate, a New York-based financial content company. "Longer life spans mean retirees holding more equities for a longer period of time to ensure they don't outlive their savings or see inflation devour their buying power over a multi-decade retirement horizon."
The 60/40 rule has led to confusion for many investors -- a survey conducted by Dreyfus, a New York-based investment company, found that 49% of retail investors were confused by the term and only 18% of respondents understand the allocation. The survey, which included retail investors who have at least $50,000 in household investable assets and investment and retirement planning advisors, found that a majority of people believe a larger holding of stocks will lead to more funds for retirement with 63% who agree with the sentiment.
In today's current market conditions, 70% of investors under the age of 35 said the 60/40 approach is outdated while 52% of investors who are 35 to 54 agree and only 26% of those who are 55 years older believe it does not work.
Asset allocations must shift as Millennials and even Gen X-ers are expected to live into their 80s.
"Like everyone, they should be looking very closely at how they have their assets divided," said Joe Moran, head of distribution for Dreyfus Corp., a BNY Mellon company. "As generations are living longer, they should take a close look to ensure they will not outlive their money."
Why Holding Stocks Is Better
Buying stocks with rising dividends is one strategy that investors can opt for without fearing what the indexes are doing, said DeShurko.
Investing in a laddered bond portfolio like the Guggenheim BulletShares defined maturity bond ETFs gives investors "a little yield, a defined maturity price if rates rise and liquidity to switch and go 'all in' to the stock market when the next great opportunity or crash arrives, he said.
"It's hard to convince clients to buy in though," said DeShurko. "The key is that you have to be willing to move out of bonds and into stocks when everyone is saying that is a really dumb idea. Even with pretty bad timing, it isn't so hard to break even with a stock only buy and hold strategy, but you have eliminated a lot of stress."
The premise of a 60/40 stock/bond mix dates back from a strategy devised by pension funds and the mix was intended to produce stable growth with bonds "cushioning" the risks of the volatility in the stock market, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa.
"Some people mistakenly want to translate the 60/40 mix from the pooling of risks setting in the defined benefit world to the defined contribution plan world in which there is no pooling of risks," he said.
Investors who are decades away from retiring should have "virtually no assets in bonds and all in stocks," and lessen the equity exposure when they get closer to not working.
"If someone has a long time horizon, he/she can suffer through some down market years in the equity markets, but the good years more than make up for those poor years in the long run," Johnson said. "Taking risk off the table right before retirement is a prudent move. My bottom line is that if you have a long term investment horizon, you should have virtually no bond exposure and I practice what I preach."
Instead of focusing on saving for retirement, the majority of investors should concentrate on investing for those years. Savers are often loath to take risk because they want to avoid the possibility of losing the wealth they have accumulated. Attaining greater wealth is accomplished more easily when investors "prudently embrace risk in the equity markets," because the stock market has returned 10% compounded annually while long-term government bonds and corporate bonds have returned in the neighborhood of 6% annually since 1926, he said.
"The volatility of the stock market is much greater than in the bond markets or with cash," Johnson added. "There is an old Wall Street adage: 'You can eat well or sleep well.' If you invest in a diversified portfolio of stocks, over the long run, you will eat well. But, you will experience some sleepless nights when the equity markets are volatile."
Since the markets are frequently volatile based on current news or the political climate, ignoring short-term trading advice and focusing instead of dollar cost averaging into a diversified, low fee equity mutual fund or equity ETF is more strategic.
"The greatest weakness of investors is their behavioral biases," he said. "It seems that to some investors, stocks are more attractive after the price has gone up. Yet, somehow, when the stock market has declined people want to sell and people want to buy when the market is roaring. The greatest ally to investors is time."
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