How Much is in Stock? The Yale Formula Rethinks the Laws of Allocation

Deciding how much of your portfolio to invest in stocks is the kind of question that can keep you up at night because there is no obvious answer. In fact, this stock allocation (the percentage of your portfolio in stocks instead of bonds and cash) is one of the biggest drivers of your long-term returns. Rules of thumb and target date funds try to simplify the process, but those investing frameworks don’t include much information about your real life.

A new formula from Yale finance professor James Choi made quite a splash when the Wall Street Journal covered it under the headline, “Yale Professor’s Investment Formula Says You Need More Stocks.” His mathematical model challenges the idea that stock allocations should decrease over time – and he created a public spreadsheet that investors can use, with surprising results for retirees and early retirees.

This approach, based on a paper written by Choi, can often lead to a more aggressive recommendation. The thinking behind it is worth a quick look.

How Future Profits Change Your Stock Shares in Retirement

The bottom line is that many allocation guidelines treat your investment portfolio as your only financial asset, when it isn’t. Choi’s formula takes into account factors such as your income, savings and investments, risk tolerance, and the amount of future earnings.

For example, if you have years of income ahead of you, or a pension, or Social Security benefits, Choi matches those sources of income with a large, stable bond. They don’t follow what the stock market does on any given day.

This means that young and old investors can hold more risk in their equity allocations than simple age-based formulas suggest. A young worker early in his career may have 100% of his portfolio in stocks because years of future income can offset any decline. If you’re 55 with substantial savings and a few working years ahead, the same portfolio risk can affect a large portion of your lifetime wealth.

As you get deeper into retirement and income sources dwindle, Choi’s formula changes accordingly, reducing the stock allocation. But the idea is based on a complete picture of your income, benefits, savings rate, and spending.

What Makes Choi’s Formula Feel More Like Financial Planning Than a Rule of Thumb

A rule like the “100 Minus Age” rule (eg, if you’re 60, keep 40% of your portfolio in stocks) uses a single variable to represent your entire financial life. Choi’s formula instead accounts for the same factors that shape the hypothetical financial system. A helpful way to apply this to your situation is to ask yourself questions that a good counselor would:

• What income does your portfolio exceed?
• How do your current savings compare to your future earning potential?
• How would you react if your portfolio dropped by 30%?

Managing a portfolio as it exists in a vacuum leads to a poor estimate of how much risk you can bear. This is the same concept that the Boldin Planner is built on: pull together your income sources, projected benefits, and expenses, and your portfolio decisions become much clearer.

Why Savings and Income Are More Important than Years Alone

The journal used a 50-year-old couple as an example. In another scenario, they earn $160,000 and have $400,000 to invest. On the other hand, they have $800,000. In the first case, Choi’s formula recommends 88% stock allocation (12% in bonds and cash), and 53% in stocks in the second case. If half of your total wealth is already sitting in your portfolio, the formula puts less of it in stocks because you have more to protect and less need to maximize growth.

An even more impressive example involves a 70-year-old retired couple with $72,000 in combined annual Social Security income and $1 million in investable cash. If they have a high risk tolerance, Choi’s formula puts them at 64% stocks compared to 30% using the “100-year minus” and 31% using Vanguard’s Target Retirement Income fund.

That assignment will probably seem too risky to some readers, but the bottom line is that what’s right for you depends on the full context of your financial life, rather than a fixed formula based on age.

How Market Fluctuations Affect Your Financial Plan

Choi’s framework is useful because it challenges conventional advice that can be too controlling, giving you the opportunity to revisit your financial situation and investment strategy. But there is a necessary nuance.

High dividend stocks are sustainable only if you can stay that way when the markets eventually go down. A 30% portfolio decline can have a big impact on your life decisions, not just your portfolio numbers.

If you’re going to be forced to sell or switch to cash during a bad market year, a strong stock dividend is probably not for you.

For employees, your industry is also important. Your income may be tied to economic cycles, such as financial, real estate, and technology jobs, meaning your job security and your stock holdings could both go south at the worst possible time. Correlations like that should be taken into account when considering adjusting your investment strategy.

Choi’s formula is one of taking the Bucket Strategy

The bucket strategy divides your assets by horizon. Near-term expenses stay in cash or short-term bonds, and money you won’t need for a decade or more goes into stocks. The point is that protecting your short-term spending means your long-term capital can weather a bad market year without having to sell anything.

Choi’s formula gets at the same idea, with a twist. Guaranteed income like Social Security does exactly what a short-term bucket does, except it sits outside of your portfolio and replenishes itself every month. Your investable assets do not require regular fees in the process. That’s what makes a 64% equity share safe for a retired couple drawing $72k a year from Social Security: the entire $1M portfolio can be a long-term investment because the short-term need is already being taken care of elsewhere.

The shared concept, whether you’re using a bucket or using Choi’s math, is to figure out what income you’re locked into before deciding how much risk your portfolio should include.

See How Much You Rely on Withdrawals Using the Boldin Planner

Whatever you do with Choi’s spreadsheet, the bottom line is that asset allocation decisions are based on your full financial picture. The important question is how much spending money you will actually need to take out of your portfolio versus what is already covered by Social Security, a pension, or other guaranteed income. That is what determines how hard your investment should work.

The Boldin Planner lets you express that. Adjust your stock and bond mix in the Portfolio section and watch your withdrawal picture change. Add your Social Security numbers and any pension or annuity money and you get a real sense of how much money has already been spent, which is exactly the question Choi’s formula asks.

Key Takeaways

• Your brokerage account portfolio is one part of your financial profile. Social Security, pensions, and any future payments provide income much like a bond, which takes some of the risk out of your carrying stock. That’s why Choi’s model tends to reach higher equity percentages than rules based on years before and after retirement.
• A high equity stake is only worth holding if you can’t hold it. If a tough market year can force you to sell, or if your paycheck tends to shrink at the same time the stock falls, then aggressive compounding probably carries more risk than the model suggests. That’s a stress test that should be done before making changes.