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How much risk?

How much of your retirement portfolio should be invested in risky assets?

This is a key question. The mix of risky vs. risk-free assets is one of the most critical determinants of long-term returns (as is your ability to stay the course). Landing on this requires considering a few key things:

1) Human capital: how stable are your earnings? Do your earnings vary with the ups and downs of the economy or the stock market? How much financial capital do you have relative to your human capital? (A 40-year-old who sold their business differs from a 40-year-old surgeon who is just starting to save.)

The more stable your earnings and the less they are affected by fluctuations in the economy and stock market, the more risky assets you can own. Are your earnings more like a dentist’s or an investment banker’s?

2) Risk tolerance: how often do you check your investment portfolio? How did you feel in 2008-09 or 2000-02? Would you throw in the towel if the stock market was down for a decade or more?

This requires “lived experience.” Borrowing from Fred Schwed, some things cannot be explained by words or pictures, you have to experience them for yourself. This includes losing a real chunk of money – perhaps multiples of your annual earnings – in a severe bear market. (I don’t view the early pandemic sell off in the spring of 2020 as a real psychological test as the market bounced back within a few months.)

3) Time to retirement: how many years until you need to start drawing on your retirement assets? How many more years could you work? Or do you want to work? Remember that this may not be 100% under your control. Life happens. And some professions have shorter (and uncertain) durations than others.


Now, let’s consider three simple scenarios:

30-35 years old, with a stable job: the good news is that your allocation to risky assets doesn’t matter much. Your career choices (or any lucky or unlucky breaks) matter much more. In theory, you could be 100% invested in risky assets. But the worst thing that can happen is a severe bear market that makes you swear off risky assets for the rest of your life. So, I would aim for something that’s 70-80% risky. You may even want to start with a lower allocation if you haven’t lived through a severe bear market.

Nearing retirement, with just enough money saved: you don’t have the ability to take much risk. If you get a bad draw of equity returns in the first decade of your retirement (e.g., 2000-2009 in the U.S.), you could run out of money. You need at least 10 years of living expenses in safe assets. If you have 20 years total, that puts an upper bound of 50% in risky assets. And it would be okay to only allocate 30-40% to risky assets.

Nearing retirement, low expected spending (~2%) relative to assets: you essentially have two separate investment portfolios. The first will be needed over the next 25-30 years to fund living expenses in retirement. The second portfolio is being invested for heirs and/or charity and could, in theory, be fully invested in risky assets. The main consideration for this second portfolio is how market downturns affect you; dial back your allocation to risky assets if a large decline would cause stress or keep you up at night.


Then there is a question of equity valuations. From time to time, the markets become irrationally exuberant* – see the late 1990s in the U.S. or the 2021 “everything bubble.” At these times, risky assets are offering low expected returns. If you are under 40 or 45, I probably wouldn’t change your mix of risky vs. risky-free assets at these times. There are exceptions, though. For example, if you are fortunate to have a lot of financial capital (relative to your human capital) due to the sale of a business or a large inheritance.

If you are approaching retirement, make sure to rebalance and consider dialing back your allocation to risky assets…a bit. If you are 10-15 years out from retirement, the answer is less clear. You could stay the course (i.e., stick with your policy allocation) or make a small adjustment to your risky allocation.


*They can also, on occasion, become overly depressed.

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