14. A Life-Cycle Guide to Investing

Dated Jun 3, 2020; last modified on Sun, 13 Aug 2023

5 Asset Allocation Principles

History shows that higher risk bears high reward

From 1926 to 2017:

Average Annual ReturnYear-to-Year Volatility of Returns
Small-company stocks12.1%31.7%
Large-company stocks10.2%19.8%
Long-term government bonds5.5%9.9%
US Treasury Bills3.4%3.1%

The risk of investing in stocks and bonds depends on the hold duration

From 1950 to 2017, the S&P averaged 10% per year. However, there were +52% and -37% on some years.

The longer the time period over which you can hold on to your investments, the greater should be the share of common stocks.

Investment PeriodPeriods when stocks have outperformed bonds
1 year60.2%
2 years64.7%
5 years69.5%
10 years79.7%
20 years91.3%
30 years99.4%

Dollar-cost averaging can reduce the risk of stock and bond investment.

Basically, you invest the same fixed amount of money at regular intervals. It requires cash and confidence, even during bleak times. This reduces the risk of entire portfolios being purchased at temporarily inflated prices.

Note that it’s not optimal. If the market goes straight up, then investing all the money upfront would have been better. (But who would have known it’ll go straight up?)

Suppose Bob, the world’s worst market timer, made these investments:

Date of InvestmentSubsequent CrashAmount Invested
Dec ‘72\(-48\%\)$6k
Aug ‘87\(-34\%\)$46k
Dec ‘99\(-49\%\)$68k
Oct ‘07\(-52\%\)$64k

After 40 years, because Bob never sold, his $184k grew to $1.1m. With annual dollar-cost averaging, it would have been +$2.3m.

Rebalancing can reduce risk, and sometimes increase returns.

Distinguish between your attitude toward and your capacity for risk.

The capacity is related to your earning ability outside your investments, therefore usually related to your age.

Don’t take the same risks in your portfolio that attach to your major source of income, e.g. all in on MSFT for a MSFT employee.

3 Guidelines to Tailoring a Life-Cycle Investment Plan

  1. Specific needs require dedicated specific assets, e.g. Young couple that needs a $30k down payment to purchase a house next year? Get a one-year certificate of deposit.

  2. Recognize your risk tolerance, e.g. did you panic when the market fell by 50% in 2008?

  3. Persistent saving in regular amounts pays off [in time], e.g. 401 (k)

The Life-Cycle Investment Guide

Cash: Money-Market Funds and Short-Term Bond Funds. Average maturity 1 to 1.5 years.

Bonds and Bond Substitutes: no-load high-grade corporate bond fund, some treasury inflation-protected securities, foreign bonds, dividend growth stocks; if held outside tax-favored retirement plans, use tax-exempt bonds

Stocks: 50% in US stocks with good representation of smaller growth companies; 50% in international stocks, including emerging markets.

Start with total stock market index fund instead of individual stocks. Beginners lack sufficient capital to properly buy diversified portfolios themselves, and the portfolios will probably be built on a monthly basis.

Real Estate: Portfolio of REIT index mutual funds.

AgeLifestyleCashBonds and Bond SubstitutesStocksReal Esate
Mid 20sFast, aggressive. Steady earnings stream5%15%70%10%
Late 30s - Early 40sCollege tuitions looming5%20%65%10%
Mid 50sRecovering from college tuitions. Plan for retirement and income protection5%27.5%55%12.5%
Late 60s+Leisure activities. Guarding against major health costs. Little risk capacity10%35%40%15%

Life-Cycle Funds are now being offered by mutual-fund complexes. It automatically does the rebalancing as you age. Implementation details differ.

Investment Management Once You’ve Retired

The average 65 year old expects to live 20 more years. The goal is to make sure you don’t run out of money, lest you be forced back into work.


Annuities pay the insurance company some sum in exchange for guaranteed periodic payments as long as the annuitant lives, e.g.

  • $1m for a $67k annual income for a 65 year old male.
  • $1m for a $56k annual income for a 65 year old couple, as long as either or them is alive.

There’s an option guarantee N years of payments to heirs upon death but that comes with lower yearly incomes.

Because inflation tends to lower purchasing power, people tend to purchase variable annuities pegged on some investment asset, typically mutual funds.

Annuities guarantee that you’ll never run out of money. However, there are a couple of disadvantages:

  • Annuitants may want to leave some money for bequests. Full annuitization goes against that.

  • If annuitants learn of some incurable disease, they may want to tour the world because of the reduced expectancy. Annuitization gives no flexibility to alter consumption patterns.

  • Annuitants pay the fees and expenses of the insurance company, and sales commission for the selling agent.

  • Annuities can be tax inefficient, e.g. variable annuities turn preferentially taxed capital gains into ordinary income subject to higher tax rates.

At least have some partial annuitization. Buy low cost and no sales commissions annuities from reputable companies such as Vanguard.

The Do It Yourself Method

Spend no more than 4% of the total value of your nest egg annually.

Although it’s highly likely that a diversified portfolio will return more than 4%, you need to allow your monthly payments to grow over time at the rate of inflation. You also need to ride out several years of inevitable bear markets.

To smoothen out the income, start spending 3.5% and then let the amount you take out grow by 1.5% per year.

Interest income from bonds and stock dividends may not meet the 4%. Start selling the portion of your portfolio that has become overweighted relative to your target asset mix.

Tap assets in a way that defers paying income taxes as long as possible, e.g. start by taking distributions from IRAs and 401(k)’s before tapping other accounts.


  1. What if You Only Invested at Market Peaks? Ben Carlson. awealthofcommonsense.com . Feb 25, 2014. Accessed Aug 12, 2023.