Generally speaking, investing in common stock tends to fit younger investors best. As we learned in the two previous sections, stocks involve several types of risk, and stock prices can fluctuate sharply. If you can’t afford - or can’t tolerate - large swings in account value, you’ll usually want to limit or avoid stocks.
As investors get older, they’re more likely to be living on a fixed income and may have less ability to recover from a major market decline.
Older investors can (and often should) keep some of their portfolio in common stock. The key is that the stock allocation typically declines with age.
Many investors use the rule of 100 as a starting point for deciding how much of a portfolio to allocate to stock. Under this rule, you subtract your age from 100 to estimate the percentage to invest in common stock. The remainder goes to bonds. For example:
| Age | Stock % | Bond % |
|---|---|---|
| 30 | 70% | 30% |
| 45 | 55% | 45% |
| 60 | 40% | 60% |
| 70 | 30% | 70% |
This guideline reflects a basic idea: as you age, you generally reduce exposure to stocks and increase exposure to fixed-income securities like bonds.
Age, however, isn’t the only suitability factor. The rule of 100 is a useful starting point, but other factors determine whether the result makes sense for a specific investor. For example:
Another reason older investors often limit stock exposure is time horizon. In the short term, the stock market can be highly unpredictable. COVID-19 is a good example. In late 2019 and early 2020, the market was near all-time highs, but then it experienced the fastest market decline in history in March 2020. Short-term market direction is extremely difficult to predict.
Over longer periods, investors can reasonably expect the stock market to rise. Over the past 100 years, there have been many bear markets and major declines. The Market Crash of 1929, which led to the Great Depression, and the Great Recession of 2008 are examples of events that caused steep market drops. Even after severe declines, the market eventually recovered and moved beyond prior highs.
We’ve already seen the COVID-19 stock market recovery, as the S&P 500 reached a new all-time high in September 2020. Recoveries can take months or years, but history shows that recoveries have occurred after every major decline. If the market never recovers, the broader economy would face problems far beyond portfolio performance.
A typical common stock investor may be seeking capital appreciation, income, or both. Some stocks are purchased primarily for capital gains, which is common for smaller growth companies or larger companies that are reinvesting heavily to expand operations. As we discussed in the benefits section, Amazon is a good example of a large growth company.
In that same section, we also discussed how companies like McDonald’s, Walmart, and Home Depot pay quarterly dividends to shareholders. These companies may not have the same growth potential as a company like Amazon, but investors can still earn meaningful returns over time by collecting dividend payments.
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