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Now that I am 47 and am starting to think about risk tolerance, I find it difficult to move my funds to safer investments as I age. I don't see a need to move money out of the stock market if I will not be drawing on it for 20 years.

Even in retirement I think I would like to only keep what I need for the next six years out of the stock market.

I live in Chicago, and I have 90% in the stock market with a 50/50 split in funds and stocks.

What does the community think about this?

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It depends on the strength of your nest egg. Your reluctance to move to more conservative investments suggests that you are confident about what have saved up for your later years. – karancan Jul 26 '14 at 13:45
This is a good question, but could you clarify? Approximately what percentage do you have in stocks right now compared to bonds? Also, where do you live, as this makes a (small) difference to my answer. – ChrisInEdmonton Jul 26 '14 at 13:47
Thanks for the question I updated the original question. – Mark Monforti Jul 26 '14 at 14:00
Thanks @karancan I think the fact I started making real money (and then saving) in 2007 when the market was so low is fueling my optimism. Also I still own stock I bought in 5th grade which has shown me how much you can make over time. – Mark Monforti Jul 26 '14 at 14:02
up vote 3 down vote accepted

You say you have 90% in stocks. I'll assume that you have the other 10% in bonds. For the sake of simplicity, I'll assume that your investments in stocks are in nice, passive indexed mutual funds and ETFs, rather than in individual stocks.

A 90% allocation in stocks is considered aggressive. The problem is that if the stock market crashes, you may lose 40% or more of your investment in a single year. As you point out, you are investing for the long term. That's great, it means you can rest easy if the stock market crashes, safe in the hope that you have many years for it to recover. So long as you have the emotional willpower to stick with it.

Would you be better off with a 100% allocation in stocks? You'd think so, wouldn't you. After all, the stock market as a whole gives better expected returns than the bond market. But keep in mind, the stock market and the bond market are (somewhat) negatively correlated. That means when the stock market goes down, the bond market often goes up, and vice versa. Investing some of your money in bonds will slightly reduce your expected return but will also reduce your standard deviation and your maximum annual loss.

Canadian Couch Potato has an interesting write-up on how to estimate stock and bond returns. It's based on your stocks being invested equally in the Canadian, U.S., and international markets. As you live in the U.S., that likely doesn't directly apply to you; you probably ignore the Canadian stock market, but your returns will be fairly similar. I've reproduced part of that table here:

Stocks/Bonds  Expected  Standard   Maximum      Largest
               Return   Deviation  Annual Loss  Drawdown
60/40         5.8%      7.8%       -14.8%       -23%
80/20         6.5%      10.3%      -21.9%       -33%
90/10         6.9%      11.5%      -25.5%       -39%
100/0         7.2%      12.8%      -29.0%       -44%

As you can see, your expected return is highest with a 100% allocation in stocks. With a 20 year window, you likely can recover from any crash. If you have the stomach for it, it's the allocation with the highest expected return.

Once you get closer to retirement, though, you have less time to wait for the stock market to recover. If you still have 90% or 100% of your investment in stocks and the market crashes by 44%, it might well take you more than 6 years to recover.

Canadian Couch Potato has another article, Does a 60/40 Portfolio Still Make Sense? A 60/40 portfolio is a fairly common split for regular investors. Typically considered not too aggressive, not too conservative. The article references an AP article that suggests, in the current financial climate, 60/40 isn't enough. Even they aren't recommending a 90/10 or a 100/0 split, though. Personally, I think 60/40 is too conservative. However, I don't have the stomach for a 100/0 split or even a 90/10 split.

Okay, to get back to your question. So long as your time horizon is far enough out, the expected return is highest with a 100% allocation in stocks. Be sure that you can tolerate the risk, though. A 30% or 40% hit to your investments is enough to make anyone jittery. Investing a portion of your money in bonds slightly lowers your expected return but can measurably reduce your risk. As you get closer to retirement and your time horizon narrows, you have less time to recover from a stock market crash and do need to be more conservative. 6 years is probably too short to keep all your money in stocks.

Is your stated approach reasonable? Well, only you can answer that. :)

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Perfect thanks. I wonder if there is a point in time that the market has been down for a 6 year window. Which is one of the reasons for my optimism in a smaller 6 year sample size. – Mark Monforti Jul 26 '14 at 14:38
The answer to that is yes. 1924 to 1932. Down 60% 1930-1954 even 1966-1974 down 40% – Mark Monforti Jul 26 '14 at 14:43
@MarkMonforti: A useful quote from the Bogleheads' Guide to Investing (see here): "Your odds of losing money in any particular year are 32%. Your odds of losing money over any 5 year period dropped to 13%, and for any 10 year period the odds of losing money fell to only 2 percent. There has never been a 15 year period where stocks lost money." – BrenBarn Jul 26 '14 at 18:29
@MarkMonforti - I suggest you look at it lets you look at returns between two years of your choosing. If you wish, you can cut/paste the data into a spreadsheet and calculate a running 6 year CAGR. It's a worthwhile exercise. My own target is to have 8 or so years of cash. Not far from your 6. – JoeTaxpayer Jul 26 '14 at 21:06

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