The classic financial planner’s rule of thumb says that the older you are, the less you should have in stocks. That idea has become the basis of a big business: Target-date funds, which are premixed portfolios of stock and bond funds, gradually shift you out of riskier assets.
They now hold more than $500 billion in assets and are often the default option in 401(k)s. (Each fund has an expected retirement date in its name. For example, there’s Fidelity Freedom 2025.) But there are countless theories about how much to hold in equities at any given age, and some fund managers even have more than one approach.
Here’s a look at the thinking behind different equity “glidepaths” used by target dates or recommended by experts, and what you must know to choose one that suits you.
Typical target-date funds
The guiding principle: The three big players — Fidelity, T. Rowe Price, and Vanguard (not shown in the table below) — keep stocks at half or more of assets by retirement age. The idea is that most people need the growth of stocks to stretch their savings. But T. Rowe Price recently opened a series of less aggressive portfolios, suggesting even fund managers know their glidepaths feel too risky for some.
How you’d use it: In 2008 the big funds for people retiring in 2010 all lost over 20%. If you can’t tolerate a late-career loss like that but like the automation of target funds, buy one meant for someone older than you.
A wild idea
The guiding principle: In this counterintuitive approach, from planner Michael Kitces and American College professor Wade Pfau, you have low stock exposure at 65, then go back up. Pfau says this deals with “sequence” risk: a bear market early in retirement that leaves you with little money to invest by the time good returns come back.
How you’d use it: The real takeaway is to be cautious at retirement time. Avoid depleting your nest egg at that crucial moment, when you have the most years of retirement to fund, and you can reach for higher returns later.
A wilder idea
The guiding principle: Yale professors Ian Ayres and Barry Nalebuff suggest young people use margin loans or options to bet really big. With leverage, you’d as much as double your stock exposure, gaining or losing twice as much as the market.
How you’d use it: Most people won’t have the stomach for this. But there’s an insight: The reason young people can take risk, says Ayres, isn’t just that they have time to ride out volatility. It’s that the money they’re betting is a small fraction of their lifetime earnings ahead. People close to retirement, by contrast, can’t lean on future income if markets fall. This is one way to shift risk away from the retirement date.
A simple alternative
The guiding principle: If all this is a headache, here’s relief: Robert Pozen, a former top executive at Fidelity, says a decent default for retirement plans is to “just hold one balanced fund.” He says a fund with 60% stocks and 40% bonds will often provide a higher return, has fewer parts to keep an eye on, and can be cheap.
How you’d use it: Having 60% in stocks at retirement is a lot, but Pozen says by then you should have a customized plan, not a default glidepath. Unlike target funds, a balanced fund doesn’t look more precise than it really is.
The “birthday rule”
The guiding principle: “Owning your age in bonds” was popularized by Vanguard founder Jack Bogle. (At 45, for example, you’d hold 45% of your assets in bonds and 55% in stocks.) It’s similar to what target-date funds do, but you move out of stocks much more quickly.
How you’d use it: If you were 65 in 2008 and followed the birthday rule, you’d have lost less than 10%, so this approach is a better fit for conservative investors than most target-date funds. You’ll have to rebalance funds annually yourself to follow the rule, but you also get to choose your investments.