There’s a stupid old rule that says you should be 100 minus your age in stocks.
The idea is flawed, especially for those trying to live off their wallets.
When you retire, you face two major investment risks: volatility and inflation.
An investment has only four characteristics: security, tax advantages, growth and income. As you seek out more of one characteristic, you give up more of the others.
Security is often described as knowing that you can get your money when you need it. Bonds (other than junk bonds) are often considered safe. When your money is available but allows you to buy fewer things, is it really safe?
If inflation has been under control for many years, it has always existed. And when inflation is low, interest rates tend to be low too. I have a relative who, since the 1980s, only invested in “safe” instruments like CDs and government bonds. Back then, you could get double-digit returns on treasury bills. Now you are barely reaching a single digit! My parent’s income from these investments dropped 90%.
What about stocks that are falling in price? It’s volatility. Since the value of stocks is a function of their somewhat unpredictable future earnings and dividends, their values rebound.
While volatility is incredibly painful in the short term, the lack of predictability is part of the reason stocks are rising and bonds aren’t. Stocks generally focus more on growth and tax benefits (with potential dividend income), and bonds generally focus more on income and security.
If you were 70 years old with total investments of $500,000 and had 70% of your portfolio in 10-year Treasury bills (paying 2%), you would earn $7,000 per year for the next 10 years plus dividends paid on your equity investments. In 10 years, 70% of your portfolio would be worth exactly what it is worth today, whether or not your personal expenses have increased.
A better strategy is to carve out two to three years of spending needs and put that amount into online savings accounts, where rates generally rise with interest rates.
Diversify the rest of your portfolio by focusing more on baskets of different types of stocks. Hold bonds as protection in case the markets fall and you don’t want to sell your stocks. Spend a percentage of your portfolio rather than the income generated by the portfolio.
Unless you have way more money than you’ll ever need, ignore this stupid age rule.
Spend your life wisely.