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. [xyz-ihs snippet="Donate"]

Numerous readers have asked about my health, and the answer is "not good." I'm not in any pain, but I suffer a lot of fatigue and brain fog, a product of two rounds of radiation, one of my brain and the other of my back. I also had a "brain incident" in August that caused me to lose the ability to read and write for a few days. All this has made it taxing to run HumbleDollar and to correspond with readers. That complicated tax question? No, you shouldn't expect an answer. And, no, sending it along twice doesn't help. What about all the recent nonsense over upvotes and downvotes? For goodness sake, children, let's move on. If you keep belaboring the same point, expect to be berated by your fellow readers, and a few downvotes are in order. End of  story. How will things play out from here? I'm hoping my energy level will return. But I could also see things spiraling down, and perhaps I'll just slip away, hardly a terrible fate. If that happens, readers will be the first to know. Elaine will make sure of that.