Investing at Every Age: A Life-Cycle Guide

A thirty-four-year-old and a sixty-four-year-old should not invest the same way. This seems obvious when you say it out loud. But a surprising number of people treat investing like it’s one-size-fits-all.

Malkiel’s Chapter 14 is the most practical chapter in the book. It answers a question every investor eventually asks: what should my portfolio actually look like?

The single most important decision

Here’s a number that should stop you in your tracks. According to Roger Ibbotson, more than 90 percent of your total investment return is determined by how you split your money between stocks, bonds, real estate, and cash. Less than 10 percent comes from which specific stocks or funds you pick.

Read that again. The individual stocks barely matter. What matters is your mix.

Five principles before we start

Malkiel lays out five rules for thinking about asset allocation.

1. Risk and reward are connected. This is the most basic law of investing. Stocks returned about 9.8 percent per year from 1926 to 2009. Treasury bills returned 3.7 percent. But stocks were negative in about three out of every ten years. Higher returns cost you more sleepless nights.

2. Time changes everything. If you held a diversified stock portfolio for any single year between 1950 and 2009, your return could have been anywhere from +52 percent to -37 percent. That range is terrifying. But over twenty-five-year periods, the worst return was only about three percentage points below average. Stocks beat bonds in 99.4 percent of all thirty-year periods since 1802. Time is the great risk reducer.

3. Dollar-cost averaging is your friend. This just means investing the same fixed amount at regular intervals. Say $500 every month into an index fund. When prices drop, your $500 buys more shares. When prices rise, it buys fewer. Warren Buffett puts it well: if you plan to eat hamburgers your whole life and you’re not a cattle rancher, should you hope for higher or lower beef prices? Same with stocks. If you’re still buying, lower prices are a gift.

Malkiel shows a real example. Someone who invested $500 in the Vanguard 500 Index Fund in January 1978, then $100 every month after that, put in less than $39,000 total. By 2009, that was worth over $265,000.

4. Rebalancing works. Say you start with 60 percent stocks and 40 percent bonds. After a great year for stocks, you’re suddenly at 70/30. Rebalancing means selling some stocks and buying bonds to get back to 60/40. Over a fourteen-year period ending in 2009, rebalancing once a year improved returns from 8.76 percent to 10.07 percent while also reducing volatility. It’s basically a mechanical way to buy low and sell high.

5. Know the difference between wanting risk and affording risk. A twenty-six-year-old with decades of earning power ahead can afford to lose money in the short term. A sixty-four-year-old widow living on investment income cannot. Your feelings about risk matter. But your actual financial situation matters more.

Malkiel tells the story of Carl, a GM foreman who saved over $219,000, all in GM stock. His salary came from GM. His savings were in GM. When GM went bankrupt in 2009, he lost both his job and his entire portfolio. Never tie your investments to the same place your paycheck comes from.

The life-cycle portfolios

Here’s the part people really want to see. Malkiel recommends different allocations depending on your age.

In your twenties, go aggressive. You have decades to recover from any downturn. Load up on stocks, including international ones and emerging markets. You have time on your side, and that’s worth more than anything else in investing.

In your thirties and forties, still mostly stocks. But start adding more bonds and income-producing investments like REITs. You’re building toward peak earning years, but you might also have a mortgage and kids to think about.

In your fifties, start shifting. More bonds, fewer growth stocks, more dividend-paying stocks. Retirement is getting closer, and you want your portfolio producing income, not just chasing growth.

In your late sixties and beyond, Malkiel still keeps about 40 percent in stocks and 15 percent in REITs. Even retirees need some growth to keep up with inflation. But the bond portion is now the majority. The old rule of thumb was: your bond percentage should equal your age. Malkiel goes a bit more aggressive than that because people live longer now.

Starting from zero

What if you have nothing saved? Malkiel says don’t despair. He shows that $100 per month at 8 percent return builds to serious money over time. Can you only do $50 a month? Cut the numbers in half. The point is that any regular amount, invested consistently over many years, adds up. Compound interest is patient. It just needs time.

Use your employer’s 401(k), especially if they match contributions. That’s free money. Use no-load, low-cost index funds. Check the fees.

If you hate managing this stuff

Malkiel has good news. Life-cycle funds (also called target-date funds) do all this automatically. You pick the fund that matches your expected retirement year. It starts aggressive and shifts to conservative as you age. It rebalances for you. You just keep putting money in. Check the fees before you sign up, but these are a perfectly reasonable choice.

Investing in retirement

This is where it gets real. A typical sixty-five-year-old has about twenty more years to live. Half will live even longer. Yet the average American retirement account has about $35,000 in it. That would replace about 15 percent of household income. Not a pretty picture.

Malkiel offers two paths for retirees who did save.

Annuities guarantee you won’t outlive your money. An insurance company pays you a fixed amount every month until you die. The downside: your money is locked up, fees can be high, you can’t leave anything to your kids, and you lose flexibility. Malkiel says partial annuitization makes sense for most people, but shop around for low-cost options.

The 4 percent rule is the do-it-yourself approach. Withdraw 4 percent of your nest egg in the first year of retirement. Then increase that amount by about 2 percent each year for inflation. At that rate, your money should last even if you live to a hundred.

Why only 4 percent? A balanced portfolio might return around 6 percent. Subtract 2 percent for inflation, and you get 4 percent of sustainable spending. If you withdraw 9 percent and then hit a bear market like 2008, you could run out of money in under a decade. At 4 percent, you survive the bad years.

Three practical tips for retirees: rebalance annually by selling from whatever asset class has grown too large. Tap your required minimum distributions first, then taxable accounts, then tax-deferred accounts. Leave Roth IRA money for last since it passes to heirs tax-free.

The real takeaway

The best time to start investing was twenty years ago. The second best time is now. Your age determines your mix. Your consistency determines your outcome. Pick a reasonable allocation, invest regularly, rebalance once a year, keep costs low, and don’t panic when markets drop.

That’s it. That’s the whole plan.

Previous: How to Predict Stock and Bond Returns Next: Index Funds and Smart Stock Picking Rules Part of the series: A Random Walk Down Wall Street Book by Burton G. Malkiel | ISBN: 978-0-393-08169-5