John Bogle does not oppose stock allocation changes in all circumstances. He believes that investors should lower their stock allocation as they age. He often advances a rule of thumb suggesting that investors go with a bond allocation percentage equal to their age while investing the remainder of their money in stocks. So a 25-year-old investor would go with a 75 percent stock allocation but an 85-year-old investor would go with only a 15 percent stock allocation.

Does this make sense?

The core idea certainly makes sense. Stocks are a volatile asset class. Investors need to be prepared for big price drops. Young investors are far better equipped to handle big price drops than are old investors. A young investor who loses a big portion of his life savings in a price crash has many years remaining to recover from the blow. And an investor who is close to retirement or in retirement does not. The older investor takes a much harder hit when stock prices fall and so it makes all the sense in the world for the older investor to go with a more cautious stock allocation.

But —

It does not make sense that Bogle is so willing to acknowledge the need for investors to adjust their stock allocations as they age while he is so reluctant to acknowledge the need for stock allocation adjustments to be made in response to big price shifts. Of the two factors, the valuation factor is the more important. It is smart for investors to change their stock allocation as they age. It is imperative that they do so in response to large changes in valuation levels.

It is not entirely true that young investors can recover from price crashes because they have so many years of investing ahead of them. Say that a 30-year-old investor loses $50,000 in a price crash because he follows Bogle’s advice and goes with a high stock allocation at a time when valuations are sky high. Yes, it is so that that investor is not finished. He has time to recover from the loss before he retires from his job. But the full reality is that his dollar loss is greater than the dollar losses suffered by an older investor. A 30-year-old investor has decades of compounding returns ahead of him. When he loses $50,000 in a price crash, he is losing not only that $50,000 but also the compounding returnsthat he would have enjoyed on that $50,000 had he not lost it. His lifetime loss is a very big number.

Young investors can afford to take on more risk. That much is fair to say. But young investors cannot afford to be glib about the risks they take on when they invest in stocks,. It makes sense for young investors to go with high stock allocations when prices are at low or moderate levels because stocks offer much higher returns than most other asset classes in those circumstances. But even young investors should be way of investing heavily in stocks when prices are high and the odds of bone-crushing losses are high.

And old investors do not necessarily need to be terrified of the prospect of suffering losses in their stock portfolios. Say that an investor has just retired at age 65 and wants to be sure not to run out of money for 30 years and stocks are priced at the rock-bottom low prices that applied in 1982. Should he lower his stock allocation to 35 percent, as Bogle’s rule of thumb suggests? I sure don’t think so. A regression analysis of the historical return data shows that the most likely 10-year annualized return for a stock purchase made when prices are where they were in 1982 is 15 percent real. The new retiree is taking on more risk by passing on the opportunity to earn an annualized return of 15 percent real for 10 years than he is avoiding by moving to a different asset class. If he earns that sort of return for 10 years, he will be so far ahead of the game that he will not have to worry from age 75 forward regardless of what the market does or where he puts his money. Why not lock in that peace of mind by going with a stock allocation of more than 35 percent even at age 65?

Valuations matter more than age. That’s the point. Retirees certainly do not want to endure large price drops that remain in effect for a long time. But those sorts of price drops do not take place at times of low valuations or moderate valuations. They only take place at times of high valuations. The retiree should be willing to give up the higher returns available from stocks only when the risk that he will suffer a severe setback is real. When stocks are priced to offer a reasonably safe ride, why not enjoy the higher returns that they offer?

Bogle advises investors never to change their stock allocations by more than 15 percent in response to valuation shifts. But he finds the idea of changing one’s stock allocation by 60 percent (from 75 percent stocks at age 25 to 15 percent stocks at age 85) acceptable. He approves of stock allocation changes of four times the magnitude in response to age changes over those he approves of for price changes. It is my view that price changes are the far more important factor. Yes, changes in age justify stock allocation changes. But it is a bigger mistake to fail to make stock allocation changes in response to big valuation shifts.

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This article by Rob Bennett was originally published at Value Walk.