Equity allocation by age: rules of thumb, glide paths and what theory says

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What should your equity allocation by age be? The best-known rule of thumb is “100 minus age”: 70% equities at 30, 40% at 60. Behind it lies a sound idea (young investors have more time and more future income), but the theory is more nuanced, and in retirement there are even arguments for an equity allocation that rises again.

The rules of thumb

The rules are simple and prevent two common mistakes: holding almost nothing but cash savings out of fear when young, and running into a crash with almost 100% equities shortly before retirement. But they take no account of what theory considers decisive: how secure your income is, how large the rest of your wealth is and how flexibly you can respond to losses.

The glide path: shifting the mix over the years

A glide path defines how the allocation moves over time, typically from a growth-oriented portfolio to a defensive one. Target-date funds do exactly this: a “2050” fund holds a lot of equities today and gradually shifts into bonds until 2050.

Instead of shifting the mix every year according to your age, you can also choose a fixed period. Example: the share of the growth portfolio falls linearly from 100% in 2036 to 30% in 2046. In 2041, halfway along, it is then 65%. Before that it stays at 100%, afterward at 30%. This concentrates the shift into the ten years before a goal, such as the start of retirement.

The glide path is a form of rebalancing with a moving target. For tax purposes, it is best to make the shift through new contributions and withdrawals first, and only then to sell.

What theory says: time horizon alone is not enough

This surprises many people: in the classic models of Samuelson (1969) and Merton (1969), the optimal equity allocation does not depend on the investment horizon. If your risk appetite does not change and you only have financial wealth, you should hold the same share in equities at 30 as at 60. The argument “a long time evens out fluctuations” does not hold in this model, because the possible losses over a long time can also be large.

Age only comes into play through human capital: the present value of future labor income. For many employees, this income acts like a large bond: it flows relatively steadily, independently of the stock market. So if you are young, you already own a lot of “bond” in the form of your salary and can invest your financial wealth all the more heavily in equities. With every year, human capital shrinks, and financial wealth has to take on a larger part of the safety.

Cocco et al. (2005) worked through this argument in a realistically calibrated life-cycle model with non-tradable labor income and borrowing constraints: because labor income substitutes for safe assets, the optimal equity allocation falls roughly over the course of a lifetime. Bodie et al. (1992) add flexibility: if you can work more or for longer when the stock market does badly, you can take more risk beforehand.

When the rule of thumb does not fit

• Uncertain income: the self-employed, business owners or employees in cyclical industries have human capital that resembles a stock more than a bond. For them, theory suggests a lower equity allocation than the rule of thumb.
• Government employees and secure pensions: a government pension or a high Social Security benefit acts like a large bond in retirement. That allows more equities in the portfolio, even in old age.
• Large wealth relative to needs: if you will never fully use up your wealth, you are effectively investing part of it for your heirs, and with their time horizon.
• Real estate and debt: an owner-occupied home with a mortgage increases the risk of your total wealth; that can argue for fewer equities in the portfolio.
• Risk tolerance: if you sell at −30%, you are effectively holding a lower equity allocation than you planned. The allocation must be one you can stick with in a crisis. A dry run in your head helps: what would a 40% fall in your portfolio mean in actual dollars?

Putting it into practice

1. Emergency fund first: three to six months' expenses in an instant-access savings account are not part of the equity allocation. They prevent you from having to sell in a crash.
2. Choose the safe portion deliberately: money market funds and short-dated government bonds barely fluctuate; long-dated bonds fluctuate more but protect better in some crises. Inflation-linked bonds preserve purchasing power.
3. Look at your total wealth: employer pensions, life insurance policies and Social Security are often bond-like and belong in the picture.
4. Set rules: a written glide path with fixed dates for rebalancing takes decisions off your hands in a crisis.
5. Review annually: if your circumstances change (new job, inheritance, buying a home), the right allocation changes too.

In retirement: falling or rising equity allocation?

Many glide paths end at the start of retirement and hold a fixed, low allocation afterward. Pfau and Kitces (2013), by contrast, examined a rising glide path in retirement: a low equity allocation at the start of retirement, then more equities year by year. The reason is sequence risk: a crash in the first years of retirement does the most damage, so safety is most valuable then. If things go well, you can bear more risk later; if they go badly, you buy more cheaply after the crash.

Theory and simulations do not deliver a universally valid number. But they show what matters: the phase around the start of retirement, secure sources of income and whether withdrawals are flexible.

For advanced readers: the models' assumptions

The independence from the horizon in Samuelson and Merton holds under strict assumptions: returns independent over time, constant relative risk aversion, no labor income, no transaction costs. If equity returns fluctuate somewhat less in the long run than in the short run (mean reversion), that again argues for more equities over a long horizon. The empirical evidence for this is, however, disputed. Borrowing constraints work in the other direction: a young person with large human capital would actually like to hold more than 100% equities but cannot borrow without limit to do so. Models with such constraints therefore produce an allocation close to 100% for a long time and only later the familiar downward path.

In practice, the Merton formula can hardly be applied directly: the expected excess return is uncertain, and even small changes shift the allocation considerably. The formula is more of a thinking tool: it shows which variables drive the allocation, and why two people of the same age can have very different allocations.

How Portfolio Lab calculates it

In Financial goals you can set a glide path between two portfolios, A (growth) and B (defensive): the share of A falls linearly between two years. The “Rule of thumb 110 minus age” button sets today's share to 110 minus your age and the share in the target year to 110 minus your age then. Contributions go into the underweight pot first, and in January the portfolio is rebalanced if the share deviates from the path by more than 2 percentage points; withdrawals come from both pro rata. The Monte Carlo simulation then shows how often the goals are reached with the glide path. Details are in the financial goals methodology.

This article explains a method; it is not investment or tax advice. Worked examples are simplified and rounded. All terms in the glossary.