A time-honored investment rule is that your asset allocation should mirror your age. So, you should allocate your money into stocks and bonds in a ratio of 60:40 at age 40, 40:60 at 60 and so on.
Ask any stock market expert or financial advisor for a proper allocation of your money, and he will tell you that you must simply subtract your age from 100 and invest that must proportion of money into stocks, and the rest into bonds or other safe instruments.
So if you are 25, you are advised to invest 75% (100-25) of your money into stocks. And as you age, your stock allocation must come down while that of safe investments like bonds must rise.
On the face of it, this logic of increasing an allocation to less-risky, less-volatile bonds as one gets older seems convincing.
As investors approach and enter retirement, their ability to earn their way out of a stock-market plunge evaporates. So does their ability to outlive a market decline.
So what is wrong with the allocation rule and the advice based on it?
Plenty! Like many investment rules, this one strikes me as grossly simplistic at best, and dangerous at worst.
Why Benjamin Graham mocked such an allocation
The most striking thing about the father of value investing Ben Graham’s discussion of how to allocate your assets between stocks and bonds is that he never mentions the word ‘age’.
This is what sets his advice firmly against the winds of conventional wisdom – which holds that how much investing risk you ought to take depends mainly on how old you are.
Unless you’ve allowed the proponents of this advice to subtract 100 from your IQ, you should be able to tell that something is wrong here.
Why should your age determine how much risk you can take?
A 90-year-old with Rs 10 crore in his bank account, a big enough house, and a gaggle of grandchildren would be foolish to move most of his money into bonds. He already has plenty of income, and his grandchildren (who will eventually inherit his stocks) have decades of investing ahead of them.
On the other hand, a 25-year-old who is saving for his higher education and a house down payment would be out of his mind to put all his money in stocks. If the stock market takes a nose dive, he will have no bond income to cover his downside – or his backside.
What’s more, no matter how young you are, you might suddenly need to move your money out of stocks not 40 years from now, but 40 minutes from now.
Without any warning, you could face troubles in your life – like losing your job, getting divorced, becoming disabled, or suffering who knows what other kind of surprise.
The unexpected can strike anyone, at any age.
As such, everyone must keep some assets in the riskless haven of cash.
Also, as I’ve seen over the past many years, many people stop investing just because the stock market goes down.
When stocks are going up 30% or 40% a year, as they did between 2003 and 2008, it’s easy to imagine that you and your stocks are married for life.
But when you watch every rupee you invested getting crushed, it’s hard to resist moving into the ‘safety’ of bonds and cash.
Because so few investors have the guts to cling to stocks in a falling market, Graham insists that everyone should keep a minimum of 25% in bonds (or other similar safer instruments).
He argues that such a cushion will give you the courage to keep the rest of your money in stocks even when they are sinking.
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