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Key Takeaways
- Traditional retirement advice may be overly conservative because it ignores human capital—future wages and Social Security—which can provide diversification.
- In practice, an all-stock portfolio may not be appropriate for everyone, especially for those working in certain industries or with lower risk tolerances.
Investing for retirement often means balancing growth with stability. For many investors, it makes sense to hold a portion of their portfolio in conservative assets, such as bonds, to reduce volatility and risk.
However, James Choi, a professor of finance at Yale, suggests that people should keep 100% of their portfolios in stocks for most of their working lives.
In a recent podcast episode of the ‘Behavioral Divide with Hal Hershfield’, Hershfield asked the economist what financial advisors could learn from academics. Choi explained that traditional financial advice is often too conservative when it comes to asset allocation.
“The reason is that a lot of the advice out there does not take into account the biggest economic asset that working people have: their working capital. In other words, the future stream of wage income and Social Security retirement benefits they have coming to them,” Choi said. “The thing to realize is that shocks to your labor income or Social Security benefits are uncorrelated with the stock market’s return.”
What This Means For You
Choi’s suggestion that people keep 100% of their portfolio in stocks may be helpful for some, but you should also consider your own financial situation. Any asset allocation strategy will affect household wealth, so it must be carefully considered.
That means your human capital, in the form of wages and retirement benefits, help provide diversification—if your stock portfolio is down, you can still count on your human capital. Choi says this income effectively functions as an enormous bond that can allow you to take more risk.
“A lot of the standard economic models that incorporate human capital would say that you should be at least 100% stocks for much of your working life,” said Choi.
However, some financial advisors point out that people often don’t act as rationally as many economic models assume.
“A 100% equity portfolio is not a modest tweak; it is a behavioral stress test. At some point, you will see a 30% to 50% drawdown, and many people will do the exact wrong thing,” wrote Jordan Whitledge, a lead investment advisor at Donaldson Capital Management, in an email. “They will sell, they will go to cash, and they will miss the recovery.”
Patrick Huey, a certified financial planner and owner of Victory Independent Planning, said that while Choi’s advice may be useful as a rule of thumb, investors should also consider their industry.
“If you work in cyclical or high-volatility industries (tech, sales, finance, construction, media), your job prospects and bonus income are highly tied to the same economic cycle that drives stock returns,” Huey said in an email.
In the podcast, Choi acknowledged both of these arguments, noting that for individuals with a lower risk tolerance, a higher stock allocation might not be the right move.
“Our academic models might say 100% stocks, or even levered positions—200% or 300% stocks—are optimal, given a certain objective,” said Choi. “But if that’s not psychologically sustainable for an individual, that might not be the right asset allocation for them.”
Choi has also created a spreadsheet that lets people receive a more personalized calculation of their recommended portfolio allocation by entering their age, income, net worth, risk tolerance, and other factors. However, he cautioned that the worksheet should not be treated as investment advice but rather as a thought exercise.
