First of all, every investor has a unique time horizen and risk tolerance, so any rule of thumb is hardly adequate. Secondly, I think the typical rules of thumb are too conservative anyway. Many people are now living well into their 90s–and a recent article in Time suggests that some women in their 20s today may live to be over 120. Additionally, careers and aspirations are changing. Few folks can or want to quit earning income and live totally off of their retirement funds at 65.

So the method of “subtract your age from 100″ or even from 115 to get the percentage of your portfolio that should be in bonds seems rather outdated. Target Retirement Date funds that allocate half of a middle aged person’s portfolio to bonds can actually be much too conservative, especially if that person has significant short-term assets outside of their retirement portfolio or if they expect to have other sources of income past age 65 such as pensions, passive income, earned income, or social security.

And yet funds that allocate smaller percentages to bonds are labled “aggressive” or even “very aggressive” which can confuse and scare away investors who wouldn’t categorize themselves with those lables. Words like “balanced” describe funds with upwards of 35% in bonds–which can actually be very conservative if you’re investing for the long haul.

I’m also particularly tired of all the articles that seem to come out of the woodwork when the market is “unstable” which ask, imply, or suggest that one should shift a larger percentage of their portfolio to bonds. Just yesterday a commenter suggested that I shift a third of my stock holdings into bonds.

Last time I checked, selling stocks when the market goes down is NOT the best way to maximize your return. Isn’t “buy low, sell high” supposed to be the goal? Besides, your allocation decision shouldn’t have anything to do with what’s going on in the market in the short term. Or perhaps I just missed the memo announcing that the media has suddenly gotten really good at predicting the market.

Personally, I don’t think ANY significant percentage of my retirement portfolio should be in bonds. I have almost 4 decades before I am legally supposed to touch my 401k or IRA. And even then, I plan to have enough “passive” income to keep me from having to totally live off my retirement funds. Plus, basically all of my non-retirement funds are in cash or bonds.

What’s your view on the stocks vs. bonds debate? What factors should determine your asset allocation?

More from Meg at The World of Wealth

A 5.00% taxable yield or a 4.50% tax-free yield.

We’ll also assume that you are in the 28% tax bracket.

So, how do you know what option is best for you?

Well, there’s a really simple formula that you can use to calculate a tax-equivalent yield so that you can compare the yields on an equal basis. The formula is:

So, for this example, the formula would like this:

So, this tells us is that if you are in the 28% tax bracket, you need to find a fixed income investment that yields AT LEAST 6.25% BEFORE TAX in order to get the same after-tax yield of a 4.50% tax-free. In this case you would be much better purchasing the tax-free option. Make sense? If not, let’s look at it another way to test our math.

Again, we will assume that you are in the 28% tax bracket and you find an investment with a taxable yield of 6.25%. Since this yield is taxable, you won’t get to keep it all. So, you want to calculate how much of that yield is going to be left after taxes. So, you can perform the following calculation, which is an alteration of the formula used above:

See, it works!

We can also calculate what the after-tax yield is on the 5.00% yield:

Which would you rather have 4.50% tax-free or 3.60% tax-free? I think it is a pretty easy choice.

A couple of things to understand about tax-free yields:

1. The higher your tax bracket, the more advantageous a tax-free yield becomes. Take a look at the graphic I put together:

So, what may be good for a high-income doctor may not necessarily be good for you. Also, what the heck are you doing getting investment advice from a doctor?

2. Just because a bond is tax-free DOES NOT mean you will never owe taxes on it. Say what? Capital gains from bonds (even tax-free bonds) are taxable. So, if you purchase a bond and then interest rates fall, the value of your bond will go up. If you SELL that bond for more than you purchased it, you will owe capital gains on the difference. The only way to avoid taxation on the bond is to hold it until maturity at which time you will get your original investment back (no capital gains). This is a whole post by itself.

Okay, now it’s your turn to weigh in. Did this post make sense? Did I miss anything?

Other Resources:

To learn the basics of bonds, visit InvestinginBonds.com, a website sponsored by The Bond Market Association.

For bond prices and yield comparisons, check out BondSearch123.com, which is sponsored by JB Hanauer & Co., and BondsOnline.com. Also, Fidelity.com and InvestinginBonds.com offer pricing information.

There was a really good article about bonds ($)by Serena Ng in this weekend’s Wall Street Journal.