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Q&A: Starting Late

Q:

I just found out that one of my best friends has no retirement saved, has about $30k in debts and is still renting at the age of 50. He has asked me for help in deciding the amount of risk he should take in order to catch-up and retire at a decent age. I told him to start TODAY using our employer's 401k up to the max employer match then start paying those debts, and expect to work into his late 60s or early 70s. My question to you is what bond to stock ratio should he be investing in? Should he be aggressive like my investments (I'm 30 years old)?

A:

First, there is still a lot of time, if your friend gets started TODAY. The time for procrastinating is past.  Try to help him create a budget that lays out all of his current spending and show him where he can cut to eke out the money needed to maximize his 401k opportunity.

Your advice to invest everything needed to maximize the employer's match is dead on. He is leaving truly free money just laying on the ground if he doesn’t. You’re also right in making debt elimination his second priority. Getting even high single-digit returns on an investment portfolio is unlikely.

Your real question is hard to answer without talking with him (and even then, it’s less science than art). To have a shot at a comfortable retirement, he needs to reach for the highest possible returns, but risk and reward are connected. That said, I don’t believe that there is any chance of the entire global equity market being worth less 15 to 20 years from now.  I certainly can’t guarantee it, but if it happens, we will probably have bigger problems than the value of our investments. 

Your friend needs to be aggressive, probably has time to be aggressive, but will he stick with an aggressive (yet massively diversified) equity portfolio when the market plummets 30% to 50%? That’s the rub. 

Logically, both he, and you, should be rooting for a terrible market to happen in the next few years. That’s because you want prices low in the early years of your regular investment plan and higher in the future.  However, even if the market tanks ten years from now, he needs to remember that he is averaging into his portfolio, buying high and low. If we expect the economy (and stocks represent that economy) to be more valuable in the future, the price you paid along the way will blur into a nice middling price.

He should be as aggressive as he can stand being, but no more. If he can honestly promise himself that he won’t change his strategy when the market drops up to 50%, he could have 90% of his money in stocks (again, well diversified). If a maximum drop of up to 30% is more his style, then stay below 50% in stocks. If he might panic at a one-year loss over 10%, his portfolio should be at least 80% invested in high-quality, low-duration bonds.

Why Bonds?

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