How much of my portfolio should be in stocks?

If you came here looking for the answer to this question, you’re not in the right place. Easy answers for challenging questions generally aren’t worth the paper they’re printed on, so if you were waiting for someone to say, “60% at Age X” or “40% if you are worried about Y”, then you can click away to another page that will give you the answer you’re looking for, but not the one that you really need.

Because really, this is about opening up more questions than giving you more answers.

If you start by asking how much stock exposure you should have, you’re missing the more important questions that you need to ask first. The starting place for your exploration of your portfolio allocation needs to be with your own goals, not with how much of a certain instrument you should have in your portfolio. Why is this the case? Because determining how much time you have to let this money grow, how much volatility you can handle during that time period, and what kind of return you need to generate to hit your goal are critical to determining the right investment for your particular needs.

In general, there are three different periods that are identified by investment advisors. You have short-term goals, typically occurring this year or in the next 1-3 years, which could be along the lines of saving for a new computer. You have intermediate-term goals, usually 4-10 years out – maybe buying a new car. Then you have long-term goals, usually 10 or more years out. These are for the big ones – saving for college, saving for retirement, buying a home, etc. – American Dream-type stuff. These are the ones that keep you up at night, either because of excitement or fear. They’re also the ones that are typically the most appropriate for stock exposure, primarily because of the amount of time you have to save for them.

Once you’ve answered that, the next question you need to ask is one of our favorites – what the heck am I actually buying? Remember that common stock can be incredibly volatile over short periods of time, but much more predictable over long periods of time.

Because of the volatility associated with owning stock, any expenses that fall into the short-term category need to be kept away from the stock market.

Let’s look at the example of buying a computer:

Suppose you need to save $1,000 to buy the computer you want. If you target to stash away $100 a month in perhaps a savings account, you’ll have the money saved in under a year. But maybe you think you can eek out a few percentage points in the stock market and cut a month off that projection, since you really want that computer. Your upside is potentially having that computer a month, maybe two months earlier if everything goes well. But suppose the market falls apart, or the company you bought stock in has a couple bad quarters and loses 30 percent. Now you have to wait a few months longer, and that’s assuming things don’t get worse during the additional time you now have to wait. I know the temptation is to try to get a little extra performance since banks don’t pay much in the way of interest, but short-term investments really shouldn’t be in the stock market.

Intermediate-term projects have a little more room for interpretation – this is where the fun happens. Over four-year rolling periods, the S&P 500 has been positive 87 percent of the time according to Don’t Quit Your Day Job. Over 10-year rolling periods, that has been true 98 percent of the time. These types of numbers suggest that you can likely have some of this money in the market, but probably not all of it. So for expenses that fall into the intermediate-term range, it becomes somewhat of a judgement call as far as how many years of protection you want to build into your portfolio. You’ll have to look at outside factors, like whether or not earned income could make up any of the gap if your portfolio that takes an unexpected dip, or whether you have other sources of funds that could be used if the market is down, and also whether or not you could potentially just wait a few extra years on whatever goal you had in mind. If you do have ways to work around market fluctuations, you can likely go a little heavier on equities with this kind of time horizon, but if you have three kids, two old cars, and you’re already working two jobs just to make ends meet, you probably need to take a little less risk because you have less margin for error.

Lastly, we come to long-term expenses. This is money that should be almost exclusively in stocks. Why? Because according to BlackRock, stock returns for the last 20 years have been significantly higher than the other two major asset classes usually available to most people in investment accounts, which are bonds and cash. While there is no way to predict whether or not this is going to unfold the same way over the next 20 years, our original question of “What do I actually own?” helps us make some predictions. With stocks, you own a portion of a company’s future cash flows. With bonds, you own a debt that a company, country, or municipality has to pay back to you. With cash, you own the ability to make transactions that have to be accepted by a merchant. Only one of those options shows the ability to independently grow over time.

So the answer to “How much of my portfolio should be in stocks?” isn’t a fixed number based on your age. It’s not based on a checkbox of what your “risk tolerance” is because, if we’re being honest, no one really knows what the dividing line is between “aggressive” and “moderately aggressive”. Rather, it’s a number that you have to sort out for yourself based on what your goals are, what the timeline of those goals are, and how bumpy of a ride you can stomach along the way. For short-term goals, keep that money safe. For intermediate-term goals, feel free to take on carefully-managed equity risk. And for long-term goals, look to stocks to be able to smooth out the short-term dips with longer-term predictability.

And always remember to re-evaluate your goals on a regular basis, because long-term goals eventually turn into intermediate-term goals, and intermediate-term goals then turn into short-term goals. Using the framework outlined above, simply adapt as you go. That’s the answer.