Pay down your mortgage. Keep a 60/40 stock-bond portfolio. Some money rules are meant to be broken.
Published: May 26, 2023 at 7:25 a.m. ET
The world is more complex, and so is money management. More information and more choices can lead to more complications. For financial advisers, the trick is reducing complexity into simple, easy-to-understand steps for clients to follow. Advisers use rules of thumb as starting points to help investors make sound money moves.
But these rules don’t always apply. They can become obsolete or misunderstood as the investment landscape changes. “Most rules of thumb work for a generalized case of the world,” said Jamie Ebersole, a certified financial planner in Wellesley Hills, Mass. “In all cases, their applicability depends upon the specific situation of the individual.”
For Ebersole, one of the most reliably helpful rules is to adopt a disciplined savings regimen. Specifically, he urges clients to save 20% of their earnings to build a nest egg.
“I throw out the 20% number, but you have to tailor it to each client,” he said. “A 23-year-old may not be able to save at the 20% level. It’s more about building that habit on a monthly basis. If you can implement a ‘set it and forget it’ saving program at any level, you’ll train yourself to live below your means.”
Ebersole favors another rule of thumb that’s a bit more controversial: establishing a 60/40 allocation of stocks and bonds in an investment portfolio. There’s debate among advisers about whether this longstanding rule still applies.
“The reason it works is that it’s a risk-balanced portfolio that allows many investors to start the investing habit without excess volatility,” Ebersole said. “Over the long term, its returns will outpace inflation and grow your portfolio.”
Ebersole acknowledges the downside of the 60/40 rule. The portfolio can underperform during prolonged bond slumps. And when equities soar, investors can miss out.
“This portfolio will never generate returns in line with the S&P 500 since this is not what it is designed to do,” he said. “But a more consistent return profile will make it easier for new savers and those close to retirement to stay invested in times of volatility, reducing the impact of emotion.”
Other advisers raise additional concerns about the traditional 60/40 split of stocks and bonds. It excludes other asset classes that can stabilize a portfolio in turbulent times, such as commodities and Treasury Inflation-Protected Securities (TIPs). And over decades, the bond portion can limit growth compared to a more heavily weighted equity portfolio.
“Typically, investors have a much longer time frame than a 60/40 suggests,” said Zach Abrams, a certified financial planner in Shaker Heights, Ohio. “We’re big proponents of duration matching: the asset allocation should match the duration of when you need those assets.”
Some rules flow from widespread assumptions about prudent money management. Take the popular idea that it’s always a worthy goal to pay off a residential mortgage.
“People think they should get rid of their mortgage debt before or during the early years of retirement,” said Brian Schmehil, a Chicago-based certified financial planner. “For older clients whose parents were in the Great Depression, they were always told to fear debt.”
It’s wiser to weigh the opportunity cost of that money, Schmehil says. If the interest rate on your mortgage is very low, consider your options. “If you’re paying under 2% interest on your mortgage but earning 4% on your cash, you might not want to pay that mortgage down,” Schmehil said.
It also can make sense to spread your cash around and invest in low-risk products such as money-market funds and certificates of deposit, rather than plow your principal into just one asset: your home.
Case in point: It’s often said that the percentage of bonds in your portfolio should equal your age. For example, a 40-year-old would have 40% in bonds while a 70-year-old would have 70% in bonds. “Something that simple can’t work,” Ebersole said. “It’s probably too cautious all along the way.”
Rules of thumb hold appeal because of their simplicity. Sticking to what advisers deem tried-and-true strategies tends to comfort anxious investors. For instance, wealthy investors may expect their adviser to produce market-beating returns via alternative investments. But that assumption can prove faulty.
“There’s this idea that to get better investment returns, you have to seek out complex things,” said Kevin J. Brady, a New York City-based certified financial planner. “Boring is a better driver of successful investing.”
Articles are not written or produced by the named representative and the information has not been verified. There is no guarantee as to the completeness or accuracy of the content. Quotes and remarks have been excerpted from conversations with the interviewer and may have been taken out of context. All remarks are hypothetical in nature and are intended to be informational only. They should not be regarded as investment advice, performance claims or testimonials. This is not a solicitation, recommendation or endorsement of any investment, investment strategy, tax strategy or legal advice. There is no guarantee that any strategies discussed will result in a positive outcome. You should discuss any legal, tax or financial matters with the appropriate professional. All investing involves risk and no investment strategy can guarantee a profit or protect against loss, including the potential loss of principal.