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An investor’s allocation to stocks and bonds is often the most consequential investment decision he or she will make. But the practice of translating investment risk into a stock to bond ratio is fraught with misunderstanding.

This is due in part to the impact of taxes on tax-deferred accounts, but even more so to assets and liabilities not shown on the typical investment statement. Put another way, if I say I have 40% in stocks, I’m describing the numerator of a fraction. But what I haven’t said, and often haven’t considered, is the denominator.

To explain, let’s consider a 60-year old single retired client who has a brokerage statement showing a $1 million portfolio, with $400,000 in a global stock index fund held in a taxable account and $600,000 in a short-term Treasury bond fund held in a tax-deferred IRA account. Her plan, which appears reasonable given her income and expenses, is to supplement her retirement income solely through withdrawals from her IRA, while leaving her stock fund held in the taxable account untouched so that it can be passed on to her heirs tax free at a stepped-up basis.

What is her stock/bond allocation? Let’s look at some versions of the answer.

1. As stated in black-and-white on her brokerage statement, she has a stock/bond allocation of 40/60. Following the dictum of “your age in bonds” mentioned by her advisor, this allocation seems exactly right.

2. However, if one discounts the $600,000 of tax-deferred bonds at their after-tax value (assuming a 33% combined federal and state tax rate) she really has only $400,000 in bonds that’s “hers.”So it might be more accurate to say that she has an after-tax allocation of 50/50. Presented this way, it seems a bit riskier to her, but in reality it is the very same portfolio described in #1 as 40/60.