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NEW RESEARCH CAN help with an age-old question: When constructing a portfolio, how much risk is too much? Especially today, with the market again near all-time highs, this is an important issue.
On the one hand, we could dismiss this concern by noting that all-time highs aren’t as uncommon as they might seem. According to one analysis, the U.S. stock market has been within 5% of an all-time high on 44% of trading days since the 1950s.
On the other hand, because market downturns have been a regular feature of the stock market throughout history—and have always arrived without warning—we should never minimize the importance of risk management. In setting the asset allocation for a portfolio, I recommend this four-step process to account for risk:
Step 1 is to make an allocation for withdrawal needs that are quantifiable. Suppose you’re retiring soon and know you’ll need $100,000 from your portfolio each year for expenses. Recognizing that past market downturns—outside of the Great Depression—have averaged five years or less, you could simply set aside five years of withdrawals—$500,000, in this case—in a combination of cash and short-term bonds. Strictly according to the math, that might be sufficient, but I wouldn’t stop there.
Step 2 is to budget for financial surprises. I recall, for example, once moving into a new home and being informed that the roof—which had been advertised as new—needed to be replaced more or less right away. While difficult to quantify and hard to predict, these sorts of financial surprises should be factored into any asset allocation.
Step 3 is to account for what I like to refer to as the Mylanta problem. The stock market’s ups and downs can be stomach-churning. Even if you’re years away from retirement or any other potential portfolio withdrawal, “paper losses” can nonetheless be upsetting. This is especially important for younger investors. Until you’ve lived through a few of the market’s uglier downturns, you may not know how you’ll react to seeing your portfolio’s balance sink.
The fourth step is to bear in mind the standard investment disclaimer that past performance doesn’t guarantee future results. Since the 1930s, the U.S. stock market hasn’t experienced a downturn that lasted more than five years. But we shouldn’t ignore the possibility that something like that might one day occur.
Consider Japan. While it may be hard to remember, Japan in the 1980s was arguably the world’s most impressive economy. That’s when it surpassed the U.S. in many industries, including automobiles and electronics. Its banks became the world’s largest, and its real estate market saw extraordinary gains. The land beneath the Imperial Palace in Tokyo was famously said to be worth more than all the real estate in California. That all contributed to huge stock market gains. But after peaking in 1989, Japan’s Nikkei—the equivalent of our S&P 500—slumped and didn’t fully recover for 34 long years. That’s why the final step in choosing an asset allocation should be to build in more conservatism than might seem necessary.
These four steps represent the traditional approach to managing portfolio risk and, in most cases, I’ve found them to be effective. But until now, there hasn’t been an easy way to connect this approach with another popular risk-management strategy known as the 4% rule. In his new book, though, William Bengen, creator of the 4% rule, shows us how the two can be used together.
If you’re not familiar with it, the 4% rule is a framework that Bengen, a retired financial planner, developed back in the 1990s. His goal was to help retirees decide on a portfolio withdrawal rate that would be sustainable over the long-term. He found that the ideal initial withdrawal rate, to minimize the risk of outliving one’s savings, should be no more than about 4%.
When Bengen rolled out the first version of his research in 1994, he made a simplifying assumption. In each of the scenarios he examined, he assumed the same asset allocation: 50% stocks and 50% bonds. That made sense because Bengen’s primary focus at the time was not on asset allocation but on withdrawal rates. In his new book, though, titled A Richer Retirement, Bengen considers other allocations. The results are extremely useful.
In looking at the full set of asset allocation options, Bengen found there to be an optimal range: Allocating between 45% and 75% of a portfolio to stocks led to the highest long-term sustainable withdrawal rates. Why? Allocations below 45% caused portfolios to lag behind inflation. Allocations over 75%, on the other hand, ran into trouble because they couldn’t recover from deep market downturns. But between 45% and 75%, Bengen found that an initial portfolio withdrawal rate of close to 5% would have been sustainable throughout a 30-year retirement.
This new data is helpful in two ways. First, it reinforces a point Bengen has always emphasized: that despite others calling it the “4% rule,” he himself never saw it as a rule. In his own work with clients, Bengen said, he regularly used 4.5%. And depending on other variables, such as the investor’s age, he felt that withdrawal rates could be even higher.
Another way this new research is helpful: It addresses a weakness in the traditional approach to asset allocation, which is that it tends to break down for higher net worth individuals.
Consider someone like Bill Gates. He could afford any asset allocation. If he held all his assets in bonds, the value of his portfolio would erode due to inflation, but because of its size, that erosion wouldn’t really affect him. Similarly, he could afford to keep everything in stocks. Market downturns would impact his portfolio, but never enough to affect his lifestyle.
While Bill Gates is an unusual case, I’ve found that this dynamic begins to apply even for “ordinary” millionaires. And while it might seem like a good problem to have, it does complicate the asset allocation decision because it means there’s no quantitative reason to choose one allocation option over another.
But with Bengen’s new research, investors now have a more tangible guideline. Even Bill Gates, the data tell us, should maintain an asset allocation within that 45% to 75% range.
As I’ve noted before, there are two answers to every financial question: what the calculator says, and how we feel about it. To be sure, the numbers Bengen present are in the category of what the calculator says. And just like the 4% rule wasn’t truly a rule, this new 45%-to-75% range shouldn’t be viewed strictly as a rule. Everyone will make their own decision. But it does help investors answer a question that, until now, had no easy answer.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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Adam: that is a great approach to determining one’s risk tolerance! I am currently looking to increase the equities portion of my AA, since our pensions more than cover our monthly expenses and Social Security will allow us to grow out savings account balances. Our library doesn’t yet have Bengen’s new book, so I’ve requested it via interlibrary loan — I want to read the book before doing anything with our current AA.
As a retiree taking distributions, I focus on the number of years’ worth of future withdrawals I hold in short term assets, protected from stock market turndowns. If I take 4% annually, and hold 60% (i.e., midpoint of 45-75%) in stock, with the balance in short to medium term treasurys, that leaves 10 years worth of future withdrawals, which I think is pretty safe. With daily reminders of how highly priced US stocks are, it causes me to consider reducing my stock exposure towards the lower end of the 45-75% range, and of course, to be sure to include international stocks in my portfolio.
Look at a graph of stocks from 1900-2025 yes the line moves up and down but the overall direction is definitely up and unless we’re entering an entirely new period that should continue.
Thank you, Adam, for this column, timely and appreciated.
I haven’t got Bengen’s new book (yet) but have read numerous reviews/opinions, and listened to podcasts about the book and its conclusions, including interviews with Bengen. Beyond widening the band of reasonable stock allocation to a range from 45% to 75% (thank you!) his model includes international, small cap, micro cap, T bills… am I missing something? that’s right, mid-cap. Of course there’s more asset class details than in 1994, we have better access to more granular information and computer power for analysis and portfolio building.
This suggest some value to individuals considering something other than a basic 50/50 or 60/40 total stock/total bonds index portfolio. And it’s resulted in a new estimated safe withdrawal rate of 4.7%.
When I review my own efforts at investing over nearly a half century, I see many (thankfully small) deviations from my earliest “random walker” style. These haven’t been because of emotion or plain foolishness so much as working with people and institutions. Maybe you remember the very limited choices available in your first, 1980’s 401k plan? (Un)fortunately, now that I’m retired, I can do lots more reading and talking and listening. Not convinced at all that it helps my portfolio, other than the constant reminders to keep my hands off.
As always, I appreciate your articles. My conundrum is the 45-75% in stocks. We are blessed with two SS accounts, one full pension, and two what I consider half pensions.
They are going to be lifelong income and they cover over 100% of our total expenses. I consider these incomes as somewhat our bond portfolio.
For that reason our retirement accounts are 100% in two broad market index ETF’s. We’ve never had bonds and we still have no bonds. Even though retired I continue to invest and are comfortable being 100% in stocks (50% VT: Vanguard World ETF, 40% VTI: Vanguard American Index and 10% Vanguard Growth.
Can any HD readers give me reasons as to why I would need bonds in my portfolio?
Opinions will vary, but for me its always been a function of : 1) how much do I have, 2) How much do I need every year 3) how much time do I have left to recover from a downturn, and 4) how much of a downturn can I stomach? I use bond funds primarily to reduce risk and volatility. I am obviously giving up something in terms of return, but as I rapidly approach age 80, I don’t think have enough time to recover from a major downturn. Had I chosen a 100% equity allocation 50 years ago, I no doubt would have much more than I do now. However, living with a 100% equity allocation is easier said than done.
Another important article, thanks Adam. I think those 4% or 5% amounts are great guidelines. Totally agree, especially when married, you have to have the right feel. We feel especially fortunate that being conservative all our 57 years of married life, that now Simpler is better and it is OK to spend more than the calculation or what the income is. As always it depends, so I get to the comfortable place by using spreadsheets and making estimates. I purposely did those to age 100, so I can make it. So far so good at 79. Every family has to make their best choice, and it is always easier with good information that you provide.
‘While Bill Gates is an unusual case, I’ve found that this dynamic begins to apply even for “ordinary” millionaires’
another way to frame this is panic vs. sleeping well….the sweet spot is in the middle..perhaps closer to sleeping well. if you doubled the net worth of many mini-millionaires it would do nothing to their lifestyle..they still would live similarly but if you halved the net worth things might get emotionally hinky..sleep being uneasy. that IS a change…
again, as was suggested, a nice problem to have but well out of he realm of real wealth where you survive off of the interest from your interest. but a sea change..to stretch the metaphor where a rising tide floats all boats a tsunami can crash us all…the sea don’t care.
Good information
Determine individual portfolio risk –
invest so you can sleep at night.
Adam, investing isn’t always simple for everyone, but you have a way to make it simpler to understand.
Another article filled with much financial planning wisdom. The 4 step process is clarifying as retirement draws near. Steps 1 and 2, check. Step 3: I learned of the “Mylanta” check from Jonathan a few years ago as he advised to take 35% off your stock allocation (the average drop in a bear market) and see how that looks and feels. If you can stomach that loss, you have the appropriate risk tolerance. If you can’t, readjust. If the scenario of Step 4 plays out in the US, we are all hosed, regardless of allocation.
I think the first step is to learn the difference between risk capacity and risk tolerance. The second step is to figure out where you fit in them at this time of your life, factoring in the perspective of your spouse.
The money stuff; investment allocation, insurance, the 10-year rule, etc., are downstream and much easier to decide afterwards.
Get the basics done right using the measurement of peace knowing you have done your best for this point in your life, then go have fun with your family.
Adam,
As always, your explanations are both very clearly and extremely well written.
Thanks for digesting all this information and laying it out for us ‘non number’ types.
Thank you for this article. This optimal range allocation is a very helpful guideline.
Would you also consider a bond / CD ladder for your safe money or maybe something else?
What about implementing Bill Bernstein’s line “If you’ve won the game, stop playing”
Adam, this is a timely article. As I approach retirement I find myself wanting to continue my aggressive portfolio. But in the back of my mind I worry about a downturn. I stayed the course during the 2008 recession when I knew I had time to recover my losses.
Funny, I asked Chat GPT how long the typical market downturns and recessions last. The answer was about 12 and 18 months, respectively. That I could handle, but 5 years? Not sure about that….
I have resistance to moving 25% of my stock investments to cash and short-term bonds. But maybe I should.
Hello Adam,
Thanks for this article. Is there any update on Jonathan? I completely understand that his illness is a private matter. I just wanted to send him and his family love.
I’m still here, but struggling. I’m currently undergoing 10 days of spine radiation, which was preceded by 10 days of whole brain radiation. I’ve also had two hospital stays in the past month. All this has left me deeply fatigued. It’s a terrible thing not to be able to think clearly!
Hang in there, Jonathan, we all want your doctors’ actions to be helpful!
Dear Jonathan,
It’s likely beyond your wildest imagination how many people wide and far keep you in their hearts and thoughts, wishing you and your family love and comfort at this difficult juncture.
I remain grateful for the gift of your financial advice over decades. Like others, I now find myself and my family financially secure in no small measure due to your repeated sound advice.
I have been successful enough to help my own kids start Roth-IRAs. I’ll be sending a similar sized charitable contribution to the Jonathan Clements Getting Going on Savings Initiative which you’ve envisioned to extend your impact to young adults whose parents have less of a chance to get their kids going financially. That this fund exists at all is a reflection of your “humble” nature.
https://boglecenter.net/gettinggoing/
Jonathan, Thank you for your update that you so kindly deliver in spite of what sounds like an especially grueling period. I also want to recognize that the fatigue you mention is often the bone deep, physical and emotional exhaustion that is very much not like what many of us who are not experiencing a health crisis label fatigue. Thank you for all that you still manage to give to us and others.
Thank you for the update. Sending much love and strength to you.
I am so sorry you are having to go through this. I hope you and your family are able to enjoy the added time you hopefully will get and in retrospect you decide it was worth it.
Thank you, Adam, for putting some of this into simple terms. I started reading Mr Bengen’s new book, but quickly found it over my head. Chris
I read the book last week, and if you go to his website he gives more instructions on how to determine your safe withdrawal rate. Basically, he said the old 4.17% rule is now more like a 4.7% rule, and he recommends a portfolio with between 50 and 75% in stocks.
Staying within that range seemed to make no appreciable difference in withdrawal rate or portfolio returns in his studies, as long as you used the recommended asset classes.
There are more details on the updates here: https://roberthuebscher.substack.com/p/rethinking-retirement-bill-bengens