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Leesa Mattress Advertiser
Foreign.
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Robert Brokamp
How much should you have in and out of the stock market? Yep. We're talking asset allocation. On this Saturday personal finance edition of Motley fool money. I'm Robert Brokamp, and it's the first Saturday of the month, which means it's time for the next installment of our 2026 financial financial planning Challenge. Because it's such an important topic, we're going to skip the headlines this week and devote more time to discussing what to consider when apportioning your portfolio. So here we go. It's month three of a year, well planned. Our 2026 financial planning challenge of the previous two months we covered coming up with systems to monitor your spending and your net worth. This month we're moving on to your portfolio and how spicy it should be given your circumstances and tolerances. And joining me to talk about it is certified financial planner and charter financial analyst Amanda Kish. Amanda, welcome back.
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Amanda Kish
Thank you so much. I'm so glad to be back.
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Robert Brokamp
The purpose of this discussion is to help listeners determine the right amount to have in the stock market, basically, and maybe the amount to keep out, as well as what type of stocks to consider. And as people might suspect, we're going to talk about the term risk tolerance, but we're actually going to start with something that might be more important and that is risk capacity. So, Amanda, what do we mean by that?
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Amanda Kish
So risk capacity is really the structural side of the risk equation. It's not about how you feel about volatility. It's about what your financial life can actually afford to absorb without putting your short term, long term goals at risk. So one good analogy that I've seen is that risk tolerance is your stomach and risk capacity is your seatbelt. So one's emotional, one is mechanical, and you need both to properly assess your individual risk profile. And the factors that go into risk capacity are things like how long until you need this money. So if you're 35 and saving for retirement, you have a very different Runway than someone who is 58 or 63. And then similarly, income stability is a factor. As an example, a tenured professor and a freelance contractor might have an identical net worth but very different capacities to ride out a bad year. And then your liquidity situation factors in as well. Meaning if the market dropped 30% tomorrow and you also got hit with a big unexpected expense, would you be forced to sell investments at exactly the wrong time or do you have cash to cushion those short term bumps? So these are all of the factors that can help to shape an investor's risk capacity.
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Robert Brokamp
So if you're a few years from a goal, right. You should probably be playing it safe with that money. Here at the fool, we generally say that any money you need in the next three to five years should not be in the stock market. Historically speaking, The S&P 500 is profitable in 84% of three year holding periods, 88% of five year holding periods, 94% of 10 year holding periods. So that's sort of where that three to five year guideline comes from. But history does say that even a 10 year holding period doesn't guarantee gains. So you should adjust it for your circumstances and preferences. And I agree with your point about how someone should consider their human capital, in other words, their jobs, right? So years ago, retirement expert Dr. Moshen Beleski wrote a book called are you a stock or a bond? With the point being, there are some people who have these jobs that are very safe, provide dependable and predictable income. So they're kind of like bonds, which means those people, theoretically at least could take more risk in their portfolios. Then you have jobs that are much more up and down in terms of the income and how much they're affected by economic downturns. And if you have that type of job, maybe you should play it safer with your portfolio. And then just another consideration is, you know, regardless of your job, you might consider whether you want to overinvest in stocks in the same industry as your employer, because you may not want too much of your net worth riding on and your portfolio and your income riding on the future of the same industry. Okay, so if we were to boil risk capacity down to a few guiding principles, what would they be?
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Amanda Kish
There are three principles that investors really need to think about. So first, consider your time horizon. So the longer your timeline, the more capacity you have. Because as you just noted, markets have historically recovered from downturns given enough time. And then secondly, you talked about the different types of jobs, so assessing the stability of your income or cash flow. So if your paycheck or if you're retired, your income sources are reliable, your emergency fund is funded, you can afford to let that ride. And then third, mentally stress test your portfolio liquidity. So would a significant drop force you to sell? And if the answer is yes, because you don't have those cash reserves, or because you're close to a goal that you need the funds for, then your capacity is lower than you might think, regardless of your age or income. And I'll throw out there that to also keep in mind that high Income doesn't automatically equal high risk capacity. So if someone has a lot of debt, more variable income, or is within five years of a major goal, college or retiring, their capacity to take on risk is going to be constrained regardless of how big that brokerage account looks on paper. So the risk capacity is really about the whole picture, not just the size of your portfolio.
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Robert Brokamp
Yeah, you mentioned a couple goals there, college and retirement. And I'll just point out that retirement is kind of a unique goal because it's not a goal with a single date, it's actually a series of goals. Right. How much you need in your first year retirement, second year retirement, third year retirement, and so on. And the studies show that what happens in that five to 10 years before your retirement, and particularly in your first five to 10 years of retirement, really has a disproportionate impact on how much you can spend over the course of your retirement and how long your portfolio is going to last. Which is why some people call this period the retirement red zone or the retirement danger zone. And it's a time to really consider your risk capacity. All right, let's move on to risk tolerance. So that's, as you said, the stomach, how much you can emotionally take the up and down of an all stock portfolio or the amount of stocks you have in your portfolio and the uncertainty in your portfolio because you don't know what the future value of stocks are going to be. And academic evidence finds that it's not static. Your risk tolerance could actually even change from day to day, but it tends to increase during bull markets because we all feel fine with risk when the stock market's going up. But then for some people, your risk tolerance plummets as the market goes down. So how can we determine our risk tolerance before things turn bad?
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Amanda Kish
That's such an important point because it's very true. Almost everyone thinks that they're a very aggressive investor when the market is up 20 or 25%. But that real test is what happens when it drops 20 or 25. That's really what risk is concerned with, is that that downside potential. So to figure out that true tolerance before we're actually in that situation, I think one of the most honest approaches is to use what I would just call a gut check scenario. So ask yourself, if I checked my portfolio tomorrow and it was down 30% and that has happened and it will happen again, what would my first instinct be? And if your answer is, I'd feel a little uncomfortable, but I'd hold study, then that's great. And if, on the other hand, your answer is, yeah, I think I'd probably start liquidating and moving into cash, then that's an important data point because that instinct right there, that's your real risk tolerance talking. And I think we've all seen that there are risk tolerance questionnaires out there that most brokerages or investment advisors have them. And they can be a good starting point for sure to get you talking and thinking about these concepts. But I would honestly put more weight on your history than necessarily a quiz. So have you invested through a downturn before? So, looking back, what did you actually do in 2020 when the market dropped by a third in the span of a couple weeks, or in 2022 when growth stocks got cut in half? So your behavior in those moments tends to be far more predictive than how you answer a hypothetical question when the market is relatively calm.
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Robert Brokamp
And you'll find some of those questionnaires online. Vanguard has one. I'm sure Fidelity and Schwab and all those folks have one. You're curious, but I agree with you. In the end, it really depends on what you actually did, how you actually felt during past downturns. You mentioned 2020, 2022. A year ago, we were close to a bear market. One thing I would say about those is they rebounded really quickly. And I sometimes worry that investors, especially newer investors, have been trained to think that, oh, if there's a bear market, it'll turn around within a year, when actually, on average, it takes two to three years for the market to get back to where it was before a bear market. And it took actually more than five years for the first two bear markets of this century, those being the dot com crash and the great financial crisis that started in 2007. So I think it's important to consider the history and how long it sometimes does take for the market to recover as you think about your asset allocation. Speaking of which, obviously everyone's different, right? But I suspect most people listening to this have a good sense of whether they're a cautious, moderate, aggressive investor. So what does that generally suggest in terms of how much they should the stock market?
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Amanda Kish
So obviously there are going to be a lot of other factors that would be in play here. So most notably, your, your age and your time horizon are going to have a big effect on that asset allocation. But I'll throw out some general ballpark ranges with of course, the big caveat that these are just starting points, not prescriptions. With that being said, I would say if you're an aggressive investor. So that means you have a long Runway and a genuine emotional comfort with volatility. Anywhere from, let's say, 70% in stocks if you're a retiree to 95, 96, 97% for a younger investor could be appropriate for you. If you're more in that moderate group, which means you are comfortable with some market turbulence. But looking to avoid the very worst of a big market decline, you might want to consider anywhere from 60 to 90% in stocks, again depending on your time horizon. And then if you fall in that more conservative bucket, which means you're someone who genuinely is losing sleep at night over volatility or who has a shorter time horizon, you may want to think about anywhere between 50% to 80% in equities. And again, that depends on where you're falling in your investing journey. Retirees are going to be want to be on the lower end. Younger investors are going to want to be on the higher end of that. And one thing I do want to emphasize is that this concept of asset allocation, the best allocation, is the one that you can actually stick with over the long run. And that means in both good times and bad. So a 90% equity portfolio that you abandon in a moment of panic is to be far worse for you, most likely than a 60% equity portfolio that you can hold steadily for several decades. So really, taking that long term view is very important.
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Robert Brokamp
Like I have?
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Leesa Mattress Advertiser
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Robert Brokamp
and if you're looking for other opinions on how you should allocate your portfolio, I always like to look at what's going on within target date funds. These are, you know, funds that are given a certain asset allocation based on a future retirement. D About every major firm has them nowadays and it's split between cash stocks and bonds, international stocks, US stocks, small caps, large caps, and it does all the rebalancing for you. So if you were going to retire, say 2040, take a look and see how the 2040 funds from Vanguard and Fidelity and BlackRock and T Rowe Price. How they're allocated might give you a general idea of how you might allocate your assets. I will say they tend to be geared towards more moderate risk investors. So then you just adjust it upwards or downwards if you are more conservative or more aggressive. All right, so now we've talked about how much to have in the stock market, but how would risk capacity, risk tolerance, these factors determine what kind of stocks you buy.
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Amanda Kish
That's interesting because the conversation then moves from how much stock to what kind of stocks and risk capacity, risk tolerance, they matter here just as much because not all stocks are created equal obviously in terms of volatility. So in thinking about the kind of stocks that are out there, larger, more established companies, perhaps, dividend paying companies tend to be far less volatile than let's say a small, small cap growth company or an emerging market stock. So a cautious investor or someone with that lower risk capacity might lean more heavily into those dividend growers to large cap value stocks or even broad index funds that tend to smooth out the bumps a little bit more. And then in comparison, a more aggressive investor that has a higher capacity, higher risk tolerance might have room for more concentrated positions, more exposure to smaller companies, or maybe even sector specific funds that have that higher growth potential, but that that come at the cost of higher volatility. And that's just why asset allocation is so important. It's not just about the mix between stocks and bonds, but also the mix of the different types of stocks that you own as well.
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Robert Brokamp
Yeah, you bring up a good point about the number of stocks you own. Here at the Motley fool we generally recommend that you should own at least 25. And for me personally that's a real bare minimum. I think most people should own more, maybe have a complement of a diversified portfolio of index funds as well. But that's something to consider. How concentrated of a portfolio are you comfortable with? And also add that seeing how a stock or a fund or an ETF perform during past downturns can provide some hint as to how it might perform in some sort of future tough times. Right. And history does not always repeat itself, so there's no way to know for sure what may happen. But if you look across your portfolio and most of your investments drop more than the overall market during previous downturns, it's probably reasonable to assume that that's the likeliest outcome during a future downturn. Same if your portfolio held up better in the past. And you just have to decide if that's appropriate for your current situation and maybe your near term circumstances as well. Let's move on to the field of behavioral finance, which has really grown over the past 25 years or so. And it has come with some biases that explain why people choose portfolios that aren't ultimately the right fit for them, or they don't actually react the most rationally at times. So are there one or two of these that are particularly worth highlighting for you, Amanda?
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Amanda Kish
Yeah, I would highlight two that I think are particularly sneaky. So the first is loss aversion, and this is one that actually has quite a bit of research behind it. So behavioral economists have found that the pain of losing money is roughly twice as powerful psychologically as the pleasure of gaining that same amount. And that means that investors often make irrational decisions in an attempt to avoid losses. So selling good assets just because they're temporarily down, so even when holding is clearly the better long term move, and that's not necessarily a weakness. It just, it's just kind of how we're wired as humans. But knowing that about yourself, it can help you at least recognize that and recognize that tendency before it tends to take over. And then the second one I'd call out is recency bias. And that's a tendency to assume that whatever just happened is going to keep happening. So after a bull market, you know, we talked about this earlier, everyone feels like they're aggressive investors, they can handle the volatility, but then after a decline, everyone feels like, oh, I should have been in cash. And the is that by the time that trend is obvious, you're usually late to react to it in either direction. And that recency bias is how people end up buying high and selling low, which is obviously the exact opposite of what we're all trying to do.
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Robert Brokamp
I'll just add another, which is herd mentality, and that's buying what's hot. Panic selling with the crowd, basically going along with everybody else. And it's understandable, right? I would throw in what you could maybe call its cousin fomo or fear of missing out when other people are doing things. It's hard not to be part of the crowd. And you know, your circumstances may warrant a balanced portfolio, right? Maybe even with a good helping of blue chip dividend paying stocks. But it may have been hard over the past few years to watch people who are all in on tech stocks make so much money, at least until the last few months. But I think the point here, of course, is it doesn't matter what other people have because you can't spend other people's money. You can only spend your own. And you need a portfolio that you can stick with, full of all the money that will be there when you need it. Well, Amanda, any final words of wisdom for us?
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Amanda Kish
Yeah, I would just reiterate what you just said. Just would remind investors that the whole goal of understanding your risk profile isn't to find the perfect portfolio, it's to find the portfolio that you can live with. Because investor who is out there earning, let's say 8% annually, they never panic. They continue to hold for the long run. They're almost always going to outperform an investor who's out there chasing, let's say 12%, 15% return. But they're moving in and out of the market. They're bailing at the worst moment. So if taking a minute or two to reflect on your true risk temperament, your risk tolerance and risk capacity helps you avoid making a fear driven decision the next time that markets get ugly, then that's more than worth it.
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Robert Brokamp
Well put. Amanda, thanks again for joining us.
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Amanda Kish
Thank you.
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Robert Brokamp
it done, Fools and it may be no surprise that I'm suggesting you take a hard look at your portfolio and determine how much you own of various assets and investments. But that can be pretty difficult if you have multiple accounts spread across multiple providers. So if you haven't yet, choose a tool to track and analyze everything that you own. It can be done with a spreadsheet, and there are plenty of free templates out there on the Internet. Just make sure you're only downloading files from sites you can absolutely trust. Then you use the data functions to update the prices of your investments as often as you like. You can also use portfolio tracking tools, and some are part of the services we've mentioned in previous episodes when discussing how to track your spending and net worth. A few to consider are Empower, Monarch Money and Quicken Premier, which can pull in the information from your investment accounts automatically. One tool that I use is Morningstar's premium investor service, which at $249 a year or $35 a month isn't cheap, though there is a seven day free trial. What I particularly like is its X Ray feature that looks into the holdings of the mutual funds and ETFs I own to let me know how my portfolio is truly allocated and how much of an individual stock I own when considering my investment in the stock and and all the funds I own that also hold the stock. By the way, you may already have access to the service to some degree. A few brokerages and personal finance tools incorporate access to Morningstar's X Ray tool, though in some cases with limitations. So all these tools that I mentioned will tell you how your portfolio is currently allocated, and Amanda and I suggested some thoughts on how perhaps it should be allocated. For a much more academic take, Professor James Choi of the Yale School of Management created a free spreadsheet based on a recent paper he co wrote entitled Practical Finance and the spreadsheet will suggest how much someone should have in the stock market based on their income, life stage, risk tolerance and portfolio size. You can find a link to the spreadsheet on Dr. Choi's LinkedIn page. And that, my friends, is the show. Thanks for listening. And thanks to Bart Shannon, as always, for being the engineer of this episode. People on the program may have interest in the investments they talk about, and the Motley fool may have formal recommendations for so don't buy or sell investments based solely on what you hear. All personal finance content follows Motley fool editorial standards. That is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show Notes. I'm Robert Brokamp. Full on everybody.