Ask the Analyst: Should I Set an Age-Based Bond Allocation?

In this Ask the Analyst series, I’m answering your questions about investing, personal finance, and retirement planning. Today’s question:

Is Jack Bogle’s advice of “age-in-bonds” total portfolio allocation a good basis? Or is “age-in-bonds” plus or minus 5% increments (with guardrails) better for retirees (given risk tolerance and/or financial goals)?

We’ll start with a little history. Earlier in his career, the late Vanguard founder John Bogle referred to setting a portfolio’s bond allocation based on one’s age as a reasonable guideline. A 20-year-old investor would allocate 20% to bonds, a 40-year-old would hold 40%, a 60-year-old would hold 60%, and so on.

Later on, he advocated using 120 minus one’s age to determine equity allocations (which sets the bond allocation to age minus 20), explaining that the previous guideline came to fruition in an era of much higher bond yields. An investor using this strategy would hold 0% in bonds at age 20, 20% at age 40, and 40% at age 60.

My take overall: The age-based bonds guideline isn’t the worst place to start, but it might end up being overly conservative. Let’s look at the question from a couple of different angles.

Test 1: Target-Date Funds

When considering asset-allocation decisions, target-date funds, which automatically adjust based on investors’ planned retirement date, can offer a useful reference point. Their asset mix reflects professional asset managers’ best thinking about the most appropriate bond position for investors at different life stages.

As shown in the graph above, age-based bond allocations are consistently more conservative than the average target-date portfolio. At age 40, for example, the typical target-date fund allocates just 9.1% of its portfolio to bonds—about 30 percentage points lower than the original version of the “age in bonds” guideline. The differences are the most extreme between ages 40 and 50, as well as after age 85.

Why the gap? While the age-based bond allocation steadily increases over time, there’s no particular reason why retirement savers should increase their bond allocations if they’re still a decade or two away from retirement. It makes more sense for them to keep a healthy equity weighting to help fuel long-term growth. Similarly, older retirees may not need to increase their fixed-income exposure over time. After the first five or 10 years of retirement, the danger zone for sequence-of-returns risk has already passed.

The more aggressive version of the age-based bond guideline comes much closer to how target-date funds are positioned. At age 65, for example, the more aggressive version would call for a 45% bond allocation, compared with about 54% for a typical target-date fund. The two still diverge at younger and older ages, though. While most target-date funds do increase their bond allocations over time, their bond allocations are relatively flat before age 50 and after age 75. As with the more conservative version, the more aggressive age-based bond guideline simply marches steadily higher over time, with the rate of increase never changing. Target-date fund allocations, however, suggest that a less linear approach might be better.

Test 2: Time-Based Portfolio Segmentation (aka the Bucket Approach)

Christine Benz has written extensively about the Bucket approach to constructing portfolios in retirement (originally developed by Harold Evensky). The general idea is to set up a portfolio in different segments, or buckets, that match the timing of when you’ll need to tap into each part of the portfolio. A typical Bucket portfolio might allocate one to two years’ worth of spending to cash, with another five to eight years’ worth of spending in bonds. Any remaining assets go in the equity bucket to help support long-term growth.

Let’s walk through an example to show how this might work in practice. For someone starting retirement with a $1 million portfolio using the 4% guideline to set an initial spending level, annual spending works out to $40,000. To be conservative, I’ll assume two years’ worth of spending for the cash bucket and another eight years’ worth in the bond bucket.

The cash bucket would include $80,000 to cover two years’ worth of spending, and the bond bucket would include another eight years’ worth of spending, or $320,000. That leaves $600,000 for long-term growth, which gets allocated to stocks. If we consider the cash bucket part of a broader bond allocation, that works out to an overall portfolio mix of 60% stocks and 40% bonds. As with the previous test, the age-based guidelines end up being more conservative. The age-based guideline would dictate a 65% bond allocation at the same age, while the more aggressive age-based guideline would land closer, with 45% in bonds.

So far, so good. But astute readers might notice that I’ve conveniently chosen portfolio balances and spending amounts that exactly match up with the 4% guideline. What if someone has a different portfolio balance and spending plan?

For example, another individual might be starting retirement with a $5 million portfolio and $150,000 in planned annual spending. In this case, the cash bucket would include $300,000 to cover two years’ worth of spending, and the bond bucket would include $1.2 million for another eight years’ worth of spending. That makes for a combined bond allocation of $1.5 million, or only 30% of total assets. The remaining 70% would go into stocks.

The Bucket approach is essentially a bottom-up approach to asset allocation. It helps investors match up the timing of planned spending with the most appropriate asset type.

The Answer Is …

Overall, age-based bond allocations are a blunt instrument. They’re OK as a rough guideline, but setting a bond allocation based on your specific portfolio size, spending plans, and risk tolerance is a better approach. Indeed, Bogle himself moved away from age-based bond formulas later in life. In an interview at Morningstar’s 2017 annual conference, he said, “A 50/50 stock/bond allocation is fine, probably if you’re younger, a little more aggressive.”

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