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Will you inherit money, or will you end up financially responsible for aging, ailing parents?

What factors might hurt your career? (If you work for a bank or a homebuilder, a jump in interest rates could put you out of a job. If you work for a chemical manufacturer, soaring oil prices could be bad news.)

If you are self-employed, how long do businesses similar to yours tend to survive?

Do you need your investments to supplement your cash income? (In general, bonds will; stocks won’t.)

Given your salary and your spending needs, how much money can you afford to lose on your investments?

If, after considering these factors, you feel you can take the higher risks inherent in greater ownership of stocks, you belong around Graham’s minimum of 25% in bonds or cash. If not, then steer mostly clear of stocks, edging toward Graham’s maximum of 75% in bonds or cash. (To find out whether you can go up to 100%, see the sidebar on p. 105.)

Once you set these target percentages, change them only as your life circumstances change. Do not buy more stocks because the stock market has gone up; do not sell them because it has gone down. The very heart of Graham’s approach is to replace guesswork with discipline. Fortunately, through your 401(k), it’s easy to put your portfolio on permanent autopilot. Let’s say you are comfortable with a fairly high level of risk—say, 70% of your assets in stocks and 30% in bonds. If the stock market rises 25% (but bonds stay steady), you will now have just under 75% in stocks and only 25% in bonds.5 Visit your 401(k)’s website (or call its toll-free number) and sell enough of your stock funds to “rebalance” back to your 70–30 target. The key is to rebalance on a predictable, patient schedule—not so often that you will drive yourself crazy, and not so seldom that your targets will get out of whack. I suggest that you rebalance every six months, no more and no less, on easy-to-remember dates like New Year’s and the Fourth of July.

WHY NOT 100% STOCKS?

Graham advises you never to have more than 75% of your total assets in stocks. But is putting all your money into the stock market inadvisable for everyone? For a tiny minority of investors, a 100%-stock portfolio may make sense. You are one of them if you:

have set aside enough cash to support your family for at least one year

will be investing steadily for at least 20 years to come

survived the bear market that began in 2000

did not sell stocks during the bear market that began in 2000

bought more stocks during the bear market that began in 2000

have read Chapter 8 in this book and implemented a formal plan to control your own investing behavior.

Unless you can honestly pass all these tests, you have no business putting all your money in stocks. Anyone who panicked in the last bear market is going to panic in the next one—and will regret having no cushion of cash and bonds.

The beauty of this periodic rebalancing is that it forces you to base your investing decisions on a simple, objective standard—Do I now own more of this asset than my plan calls for?—instead of the sheer guesswork of where interest rates are heading or whether you think the Dow is about to drop dead. Some mutual-fund companies, including T. Rowe Price, may soon introduce services that will automatically rebalance your 401(k) portfolio to your preset targets, so you will never need to make an active decision.

The Ins and Outs of Income Investing

In Graham’s day, bond investors faced two basic choices: Taxable or tax-free? Short-term or long-term? Today there is a third: Bonds or bond funds?

Taxable or tax-free? Unless you’re in the lowest tax bracket,6 you should buy only tax-free (municipal) bonds outside your retirement accounts. Otherwise too much of your bond income will end up in the hands of the IRS. The only place to own taxable bonds is inside your 401(k) or another sheltered account, where you will owe no current tax on their income—and where municipal bonds have no place, since their tax advantage