If you are trying to figure out how much you need to save for retirement or determine how much life insurance you should have, financial rules of thumb can be a helpful starting point. But as your situation becomes more complex and your level of wealth grows, rules of thumb can go from being helpful to detrimental to your financial well-being. For example, a rule of thumb for allocating your portfolio is to subtract your age from 100 to determine how much you should invest in stocks. If you are 40 years old, using this formula may not be a terrible result. You’d have 60% in stocks which would give you pretty good potential for growth over a long time horizon. It may not be not be perfect, but you could do worse than following that formula. Likewise, if you are trying to figure out how much you can withdraw from an investment portfolio, the “4% rule” (which refers to research showing that 4% is considered to be a sustainable withdrawal rate over the long term) can give you a reasonable basis for understanding how much you can live on. Complexity Requires Customization The problem with these rules, however, is that they are only averages. They can work if you have a very straightforward situation: • An average level of risk tolerance • Completely liquid investments • No big financial goals in the future • No unusual income in retirement But as soon as your situation starts to become more complicated, the rules of thumb lack the personalization needed to adequately address your needs. Here are some common examples of some complicating factors: • You own investment real estate or business interest in addition to your 401(k) and other investment accounts. • You have a goal to buy a vacation home three years from now or pay for a big international family trip every five years. • You have other sources of income in retirement such as a monthly pension, consulting income for a period of years, or a note receivable. Allocation A mistake we see people make very often is the tendency to fail to see the big picture when it comes to investing. For example, imagine an investor who has a $5 million portfolio allocated accordingly between various accounts (i.e., 401(k), IRAs, brokerage accounts, and other savings). Now if this same individual owns a business that is worth $5 million and investment real estate that is worth $2 million, their allocation actually looks like this. It is important to include those other (illiquid) assets when making investment decisions on, say, a 401k or joint investment account. Why? Because it is all part of a bigger pie, and you should think about how it all fits together. As an example, if your business is in technology, you may want to reduce the technology exposure in your liquid portfolio so that you mitigate your risk tied to that one sector. The point is that rules of thumb cannot capture this type of complexity and can cause you to look at decisions more myopically and less comprehensively. Withdrawal Rate A classic rule of thumb is the age-based idea of reducing equity exposure as you get older. The basic premise makes sense: have more money in “safer” investments as you begin to need to make distributions to fund your living expenses so you’re not forced to sell equities at inopportune times. But what if you are 85 years old with a large investment portfolio and have no need to withdraw money from it now or anytime in the foreseeable future? We’ve had several clients in this type of situation over the years, and their time horizon is actually not their own lifetime but, instead, it is the timeline of their heirs. In those cases, a much more aggressive allocation can be warranted. At Brown and Company, we use a tool we’ve developed called the Withdrawal Stress Test™ that is designed to illustrate the theoretical sustainability of an investor’s portfolio depending on the rate of withdrawal. A portfolio with a lower withdrawal rate is not only more sustainable over a longer time-frame, but it also affords an investor with the ability to likely withstand more stock market volatility. That’s why you will see in the chart above that as the withdrawal rate on the left side decreases, the percentage in stocks increases. It does not mean that you have to increase your allocation in stocks, but simply that you have the ability to withstand more volatility. A tool like this shows that, regardless of a person’s age, if they have little need for the money in retirement, they can afford to investment aggressively, while someone who has a much greater relative income need will have a plan that is much more sensitive to downside market risk. The Withdrawal Stress Test™ is predicated on the belief that portfolio allocation needs to be adapted to fit an individual’s unique circumstances and goals. In other words, personal finance needs to be personalized far beyond the capacity of financial rules of thumb. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal.