Rethinking this bond allocation should match your age formula

Posted on September 23, 2013 by | 25 Comments

Rethinking this bond allocation should match your age formula

David Swensen’s book Unconventional Success mentioned that investors should construct a portfolio with monies allocated to the core asset classes below, keeping a bias towards equities:

  • 30% Domestic Equity (VTI)
  • 15% Foreign Developed Equity (VEA)
  • 5% Emerging Markets (VWO)
  • 20% REITs (Real Estate Investment Trusts) (VNQ)
  • 15% U.S. Treasury Bonds (SHY)
  • 15% TIPS (Treasury Inflation Protection Securities)

Add up bonds and treasuries and that’s 30% fixed income folks.

Many financial experts including a famous one, John Bogle, have stated as you age you should consider this rule of thumb:  “roughly your age in bonds”.  So, that means if you’re 45 today then roughly 45% of your portfolio should be in high-quality bonds.  Although Mr. Bogle has described this idea as “a crude starting point” it remains a rule of thumb for many investors.

Here’s my (revised) desired allocation:

  • 60% equities (now includes up to 30% foreign assets)
  • 10% REITs (mostly domestic REITs)
  • 30% bonds (comprised of individual bond ETFs…read on for revised thinking below)

I used to hold many bonds in my individual portfolio using bond ETFs but I’ve reduced our bond holdings to zero over the last couple of years. We’re 100% equities now.  I’ve decided to go this way for two key reasons:

  • One, although dividend paying stocks should never be considered bonds (because they’re not) they can provide steady income.  The basket of 40+ stocks I own from Canada and the U.S. should provide some healthy reliable retirement income.
  • Two, I’m fortunate enough to have a defined benefit pension plan at work and because of this I consider this pension “a big bond”.  If you’re lucky to have a defined benefit pension plan you might want to consider more equities in your portfolio.

There is of course no one-size-fits-all-investing-recipe and because of that I’m not suggesting you sell your fixed-income assets.  On the contrary, bonds are an important asset class and are critical to investors that don’t have any sort of pension plan or similar fixed income component to rely on.  Further to that, bonds help level-out portfolios when stock markets tank.  As I mature my financial acumen I’m rethinking many financial rules.  Every financial rule requires a personal interpretation.

What about you?  What’s your take on the bond-allocation-should-match-your-age formula?  Follow it?  Don’t care?  Never heard of it?

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25 Responses to "Rethinking this bond allocation should match your age formula"

  1. Dividend Wisp · Edit

    I’m not a big fan of bonds at the moment, with interest rates being so low, and being in my mid twenties where there is a lot of time for quality stocks to appreciate over time for me.(yay compounding!) I recently sold off my bond ETF to help buy a larger stock purchase. As for REIT’s, I quite like their higher yields, steady monthly distributions and no property/tenant management!

    Reply
    1. Mark · Edit

      Same Wisp. And, given your mid-20s age, you should be focused on equities as well.

      I like REITs as well. Act like Donald Trump, no bad hair, no bad tenants and you still get paid 🙂

      Reply
  2. Prasanna · Edit

    I am of the view that just like price movements in the stock market, it is difficult to predict the date of death for a majority of us. So, we need a substantial bias towards equity all the time. You need bonds to re balance when stocks tank. That’s it. So, the maximum I will have in bonds in 30% no matter how old I am.
    By the way, this blog is extraordinary and ranks right up there with the Canadian Couch Potato.
    Best, Prasanna
    Maple,ON

    Reply
    1. My Own Advisor · Edit

      Prasanna,

      Well said. The future is always uncertain, and my latest post was a knock on financial experts who think they know better!

      I think the 30% bonds is a good target, not too high, and not too low.

      Thanks very much for the kind words about my site. Any comparisons to Canadian Couch Potato are a great compliment! 🙂

      Reply
      1. Prasanna · Edit

        I am glad that you agree on the 30% as it validates my asset allocation. Most people think of retirement years up to only say 65. But forget that there is another 15-20 years after that. So basically even after 65, with another 20 years in front, we are looking at a long-term asset allocation model with much more equity and bonds.
        Prasanna.
        Maple,ON

        Reply
  3. Daisy @ Prairie Eco Thrifter · Edit

    I’ve heard of this formula. Is your revised desired allocation based on a 45 year old? Bonds are very, very safe. The reasoning behind having your age match bond allocation is because people have more to lose as they age as they don’t have the time that a younger individual has to get money back. I do think the age/bond allocation formula is a little too safe.

    Reply
    1. My Own Advisor · Edit

      My bond allocation is based on someone in their mid-late 30s. Bonds are safe, but long bonds in rising interest rates climates will get hit.

      I think the bond allocation matches your age formula is way too safe given market conditions today.

      Reply
  4. Peter · Edit

    Hey Mark, good article. I am mid twenties, and I have bond allocation of 8%. Trying to increase that a little bit, maybe up to 15% if I can. I won’t have any pension as it stands right now, so I probably do need a bit more bonds, but I think I can tolerate the low % for now.

    Reply
    1. My Own Advisor · Edit

      Thanks Peter. I always enjoying hearing from readers like you.

      An 8% allocation is low, and if no pension, yeah, probably need a bit more but that said it really depends on your investing timeline and risk tolerance. If you have no problem with equities going down 30% or more, and you won’t get gulled into selling equities at low prices (and instead you buy them) then having a small fixed-income allocation in your 20s is not really an issue in my opinion. I suspect you’re not retiring until your 50s or so?

      For those that get scared off when they see their portfolio down 30% or more, they need more bonds.

      Reply
  5. Mat · Edit

    Huh…this is something that I have never thought of and in principle I agree. I currently hold 15% in bonds but like you, I have a DB pension as well and I’ve never really looked at it as part of my ‘bond’ allocation. If I take my DB into account, my bond allocation is close to 50%, well above the 30% I am aiming for. I think I am going to strongly look at liquidation my bond ETF allocation and build my DG portfolio.

    You can read a thousand articles and often not learn much or in some case never completely clue in and sometimes an a simple article/post can prove to be enlightening. For me…this article was the latter….thanks!

    Reply
  7. Liquid · Edit

    I disagree with Mr. Swensen’s strategy as well. I think portfolios are too personal to paint everyone’s household with the same brush. Like you mentioned, someone with a defined benefit pension plan may not necessarily need a whole lot of fixed income in their portfolio. Also couples who plan to have children should probably have a different risk tolerance than those who don’t plan to have any dependents 🙂

    Reply
  8. Matt · Edit

    I am 100% equity besides dividend accumulation that still comes because of Synthetic DRIPS on my Dividend Stocks. I am a 100% Dividend Growth Investor and feel more than comfortable with being all in equities. I am looking at my income first, portfolio worth second.
    If we have a correction or crash, I will be running to the bank for an RRSP Loan to top up all that I can. When you are able view crashes and corrections that way, I don’t see the value of fixed income to be honest, especially with today’s net negative rates.

    Reply
    1. My Own Advisor · Edit

      I run a number of synthetic DRIPs on my stocks. Some I do not, but I feel I have enough shares and need to build positions elsewhere.

      I’m becoming more comfortable being 100% equities (including REITs) and almost 0% bonds in my individual portfolio. I didn’t always feel this way.

      Income first (security) and portfolio value (a nice outcome) is a good way to look at things. Of course, I’m biased as a dividend investor.

      Thanks for your comment Matt. Stop by again soon.

      Reply
      1. Matt · Edit

        At first I didn’t like the Synthetic Drips,, but once you are set up to get at least one commission free stock per investment, I kind of like it better as you are running a DRIP and you get to pool $$ to invest where you see fit as well.

        Reply
  9. JC @ Passive-Income-Pursuit · Edit

    I have to agree on bonds, especially now, not making up a huge portion of your portfolio. Face values of bonds are only going to decline. If you’re going to have much exposure to them, then buying individual bonds makes more sense because you won’t be subject to the whims of the average investor that rushed to bonds for their safety and are still holding on. If you have a pension then I’d be even more weighted towards equities than the standard rule. Since in the US we have Social Security, counting that as a fixed income portion of your overall portfolio makes perfect sense. Wish I could say I came up with that, but we can credit Mr. Bogle.

    Reply
    1. My Own Advisor · Edit

      Par values are going to sink, no doubt, with rising yields. Most savvy Canadian investors I know are buying individual bonds, if anything at all. Some are adding bonds, but that is only for portfolio re-balancing purposes, which makes sense.

      Otherwise, go short bonds or don’t go bonds at all.

      Got your eye on any U.S. stocks? O:US seems priced well?
      Mark

      Reply
      1. JC @ Passive-Income-Pursuit · Edit

        There’s nothing that I’m overly excited about right now, although some of the Reit’s are still pretty attractively valued right now. The market started giving some better opportunities in late August/early September but now not so much. I think the best options right now is to either build cash or invest in the bluest of the blue chips as some of their prices have started to get reasonable, but still a bit high.

        Reply
  10. Ben · Edit

    I agree with you that using a future stream of fixed income from a pension should allow you to take on more risk in your portfolio. Bogle even said something similar recently that those in the US with social security income should factor that into their asset allocation decisions.

    Aggregating all assets allows you to see the bigger picture and make more informed decisions. Good post.

    Reply
    1. My Own Advisor · Edit

      I didn’t see that Bogle article…do you have a link to it?

      I didn’t always look at my assets in an aggregate and I do know, which is really helping me understand where to focus for investing purposes.

      Thanks Ben. Oh, I got your email, I will respond when I can.
      Mark

      Reply

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