Introduction & Hosts

Madison: Hello, everyone, and welcome to Not Just Numbers, Honest Conversations with a Financial Advisor and Lawyer. I am Madison Demora, and I’m here with Mike Garry. Mike is a financial advisor and a CFP practitioner and the founder and the CEO of Yardley Wealth Management. He is also an estate planning lawyer, and his law firm is Yardley Estate Planning. Hey, Mike.

Mike: Hey, Maddie. How are you today?

Madison: I’m good. How are you?

Mike: I’m good. Thanks for asking.

Episode Overview: The Yale Professor’s Formula

Madison: Good. So today we’re diving into a really interesting Wall Street Journal article about a Yale professor who says most people might actually need more stocks in their portfolio, and his reasoning is pretty compelling. At a high level, his formula says this, instead of just using your age to decide how much to invest in stocks, you should look at your entire financial picture, including your income, how much you’ve already saved, your future earnings potential, and your personal comfort with risk. One of the biggest ideas behind it is that your future income, your paychecks over time, acts a lot like a stable asset, almost like a bond. So, if you’re younger and still have decades of income ahead of you, you may actually be able to take on more stock market risk than traditional rules suggest. So, it’s a more personalized and in many cases more aggressive way to think about investing. Mike, I’m curious, what was your reaction when you first read this article?

Mike: Yeah, this is a fun one. You know, it’s interesting when academic research starts making its way into real world investing conversations. And real ones, not, like, archaic stuff. A lot of the stuff we see just has no implications for anybody other than, like, one out of a thousand people. I mean, this implicates everybody. Everybody should talk about this.

What Is the Formula Actually Trying to Do?

Madison: All right, so let’s start with the basics. This formula from Yale professor James Choi, what is it actually trying to do?

Mike: At a high level, it’s trying to answer a question people have struggled with forever, how much of my portfolio should be in stocks versus safer assets like bonds? But instead of using simple rules like 100 minus your age, or a 60/40 portfolio, which we’ve discussed at nauseam here. This formula looks at your entire financial life, your income, savings, future earnings, and even your personality when it comes to risk. I do want to say that they talk about stocks and then they call them safer assets like bonds. I don’t know that they’re necessarily safer. So safer in the sense that, you’re more likely to get your money back. So if you buy a government bond, the government can print money to get your money back. So you’ll get that back. But then any other bond will have some sort of risk of default. But then like the bigger risk is it’s not necessarily going to keep up with inflation. So I think it’s kind of a misnomer to say, like, bonds are safer assets. Like maybe in some ways you could see how they could be. Or maybe in times of market stress, they feel like they are. But I am glad that an academic is saying, like, hey, look at your whole financial life and let’s put this together and figure out. Maybe I don’t necessarily agree with all this formula, but I think it’s a great place to start.

Madison: Awesome.

Why Simple Rules of Thumb Fall Short

Mike: You know, Maddie, the other thing is that people look at simple rules of thumb, and you know, maybe 60/40 is one thing because historically that might make sense for a pension because they have to make current distributions to current retirees. So, they need to have some amount in bonds and cash. But rule of thumb, like 100 minus your age or updated to 120 minus your age, that has no meaning really. Like, maybe somebody thought that might make sense, but it doesn’t, it doesn’t mean anything. So, 100 minus your age, so a 10-year-old should have 10% in bonds, like for what?

Madison: That’s a really big shift. Most people are used to those rules of thumb.

Mike: Right, right. But yeah, they’re silly. If we could come up with good rules, that would be good. And 60/40, you know, for a pension, I could see that makes sense. Or somebody like in retirement taking distributions that might be a good place to start and then adjust it based on their personal factors. How about we go with that?

Madison: Awesome.

Your Future Paycheck Behaves Like a Bond

Madison: And one of the most interesting parts of the article was the idea that your future paycheck actually behaves kind of like a bond. Can you explain that?

Mike: Yeah, you know, again, I don’t know if I agree with his thinking, but his thinking is your future earnings, like your salary over the next 20, 30 years are relatively stable compared to the stock market. So, if you’re young, that human capital acts like a big steady asset because of that you could afford to take more risk in your investment portfolio, meaning more stocks. I don’t know if people have been in the workforce 20 or 30 years think of like their job as being relatively stable unless they have like government and union employment that is stable. A lot of other people have to change jobs pretty frequently. So, I guess I get what he’s saying, although I don’t know that everybody would agree with that.

The 25-Year-Old Example: Why Young Investors Can Take More Risk

Madison: Yeah. So, they gave an example, a 25-year-old making $70,000. The formula actually recommends a more aggressive portfolio.

Mike: Yeah, exactly. Even if the market drops 20%, that person still has decades, a half century of income ahead of them. So, they can ride out volatility much more easily than someone nearing retirement. So, in my opinion that makes sense. Right? A 25-year-old, again, why would they have any bonds, especially in the retirement? In your 401k, you’d have no reason to have bonds if you’re 25-year-old making $70,000. It’s easier to ride out that retirement, that volatility better than someone who’s 60 and is facing retirement.

Madison: Yep, that makes sense. But then the article flips it a bit when it talks about older investors or even people with more savings.

When the Formula Gets More Conservative: Older Investors and Larger Portfolios

Mike: Right. And it gets interesting here. I mean the formula actually becomes more conservative as your savings grow, not just as you age. So, if you’re a middle-aged couple with a large portfolio, adding more stocks increases the risk across a bigger portion of your total wealth. That’s why the model might recommend something like 53% stocks instead of something higher. And again, this is where I would take issue with the professor’s idea of risk. You know, if you’re a 50-year-old middle-aged couple that has a healthy portfolio, if you only have 53% of it in stocks and you have a 30-to-40-year life expectancy left, you are going to become steadily less wealthy throughout your time, throughout your life. And maybe that’s fine, but I don’t know that anybody feels that way. Like I was 50, I didn’t think like, oh, well, I want to be less wealthy for the rest of my life every year because my money’s going to erode because it’s half of it’s not adjusted for inflation. Right? So you know, I would recommend something higher than that 53%. I get what he’s trying to say, but I disagree.

It’s About Your Total Financial Picture, Not Just Your Account Balance

Madison: Yeah, so it’s not just age, it’s how much of your total financial picture is already built.

Mike: Right. You know, it’s really about your lifetime resources, not just what’s in your investment account today.

Risk Tolerance: The Personal Variable That Changes Everything

Madison: Yep. Another piece I thought was important was the risk tolerance. The formula actually asked people to rate themselves from 1 to 10.

Mike: Right. That’s huge. So, two people with the exact same finances could end up with very different allocations. If you’re comfortable with risk, say a 3 out of 10, you might lean more heavily into stocks. But if you’re seven or eight, you’ll actually tilt more conservative, more bond. Again, that is measuring the risk is in terms of volatility, like short term volatility and risk of loss, not the risk of losing your purchasing power over time due to the erosion from inflation. So, maybe I should stop taking issue with the professor. Because you know that that part of it’s not going away.

Madison: Yeah. And that’s something we see all the time in real life. It’s not just math, it’s behavior.

The Perfect Portfolio Means Nothing If You Panic

Mike: Right. 100%. The perfect portfolio doesn’t matter if you panic and sell during a downturn. You know, whatever your portfolio you have, it has to be one that you can live with the volatility and downturns. Right. Because if you can’t, then it’s not the right portfolio for you.

Maximizing Lifetime Utility, Not Just Wealth

Madison: Right. Now one thing the professor pointed out was this formula isn’t about maximizing wealth. It’s about maximizing lifetime utility. That’s a little more academic. What does that mean in plain English?

Mike: I’ll try to translate for you. Basically, it means getting the most satisfaction out of your money of your lifetime, not just ending with the biggest number. So, each additional dollar matters a little less than the one before it. It has less marginal utility. So, the goal is balancing growth and stability over so that you can actually use your money effectively. I mean, and that is a good thought. I do like that aspect.

Madison: Yeah. It feels more realistic than just chasing returns.

Mike: Right. And interestingly, the research shows that this formula gets very close to the optimal portfolio. Much closer than common rules of thumb.

The Formula’s Limitations

Madison: It’s not perfect. There are some limitations.

Mike: Definitely. You know, it relies on estimates of future income, market returns, life expectancies, and those are all uncertain. It also doesn’t account for things like home equity or mortgage debt, which are big parts of people’s financial lives.

How to Actually Use This Framework

Madison: So how should someone actually use something like this?

Mike: As a framework, not a prescription. It’s a great way to start asking better questions, like how stable is my income? How much have I saved? How comfortable am I with risk and the different kinds of risks? Right. So those are the right inputs, even if you’re not plugging numbers into a spreadsheet.

Saving Matters More Than Allocation

Madison: And one of the closing points in the article said the idea that how much you save actually matters more than how you allocate it.

Mike: That’s the big takeaway, Maddie. Asset allocation is important, but it’s secondary to saving consistently, staying invested, avoiding big mistakes. You know, there are all kinds of things that are much more important, right? Like, if you can save a little bit more every year, if you are insured against catastrophic risks, you do all these other things about your financial lives. Whether you’re allocated 60% to stocks or 70% to stocks, it’s going to be a rounding error on your likelihood of success. The important things are, you know, like having a plan, saving consistently, staying investing, avoiding big mistakes and unnecessary risk so you can have the perfect allocation. But if you’re not saving enough, it doesn’t matter.

Summary & Key Takeaways

Madison: So, if we had to sum all of this up, what should listeners take away?

Mike: I’d say your portfolio should reflect your whole financial life, not just your age. Younger investors can often afford more stocks than they think. You know, as your wealth grows, managing risk becomes more important, and most importantly, focus on saving first, allocation second.

Madison: That’s a great place to land. This was a really interesting shift from the usual investing advice. And honestly, a good reminder that personal finance is actually personal. Thanks as always, Mike.

Mike: Maddie. Anytime.

Closing & Contact Information

Madison: For more information on Yardley Wealth Management or Yardley Estate Planning, you can visit our websites at yardleywealth.net and yardleyestate.net. You can also follow us socials at Yardley Wealth Management. Don’t forget to subscribe to our YouTube channel. This podcast has been produced by Madison Demora and Mike Garry, with technical and artistic help from Poe Productions.