Don't use old rule of thumb for retirement asset allocation

By DAVID MOON, Moon Capital Management
February 17, 2008

Two things happen as a person approaches retirement. First, he gets excited about all of the things he is going to do with his newfound free time: Fish. Play with grandkids. See if Bob Dole's pharmaceutical advice is really any good or not. Things like that.

Those things are good.

Some impending retirees do another thing: They sell all of their stocks and move the proceeds to bonds or cash.

This...not so good.

Their rationale goes something like this: 'As long as I was working, I could withstand a loss in the stock market; I had years to make up for it. But I'm only six months away from retirement. Anything can happen over this short a time period.'

If the return on the stock market during the next 180 days affects the plausibility of your retirement plans, quit worrying about your asset allocation. You're not financially ready to retire. The stock market is going to decline 20 percent, perhaps in a period as short as six months. It might not be in the next six months, but over the next 20 years, the market is going to have some nasty declines.

If you're going to retire in six months, your investment horizon isn't six months. If, however, you plan to die in six months, then maybe your investment horizon is six months ' but only if you don't have any survivors to support.

You may have heard old rules of thumb that assist investors in unemotionally reducing their exposure to stocks as they get closer to retirement and throughout retirement. Of course, these rules of thumb completely ignore individuals' specific situations, such as their income needs or whether or not they are going to choose to pay for their kids to go to college until they are 35 years old.

One popular rule of thumb is to determine an appropriate amount of your portfolio to put into stocks by subtracting your age from 100. If you are 65 years old, you should put 35 percent of your portfolio in stocks.

Huh? My kids are seven years old. Why should they own anything but stocks? Why should a 50-year-old, maybe 15 or 20 years from retirement, consider putting as much as half her retirement plan into bonds?

Some other sources suggest subtracting your age from 110, not 100. This would require my children to open a margin account.

Other rules of thumb suggest that there are certain fixed allocations that are 'safe' (perhaps 20 percent stocks and 80 percent bonds), 'moderate,' and 'aggressive.' These terms don't take into account things like the value of various asset classes at any particular time. What kind of bonds do you mean? Long-term bonds? If interest rates are low and in danger of increasing, it is entirely possible that long bonds might be much riskier than many stocks.

An old wives' tale tells us that the term 'rule of thumb' originated from a 1782 British law that allowed a man to beat his wife with a stick as long as it was no thicker than his thumb. Fortunately for petite wives of large-thumbed husbands everywhere, there is no record of such a law ever existing.

The stick, however, should be used on whoever uses old tales to make asset-allocation decisions or recommendations.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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