How Much Should You Hold in Shares When Markets Are Expensive? Templeton's Rule

How much should you hold in shares when the market is expensive? Most investors answer with a feeling. Sir John Templeton, one of the most successful investors of the last century, answered with a rule: as the market climbs above its normal valuation, steadily hold less in shares, and as it falls below normal, steadily hold more. This guide walks through his dynamic allocation rule, maps it onto today's Shiller CAPE ratio, and explains why rebalancing, not prediction, is how wealth is built over time.

In this guide: The most common mistake · Templeton's rule · Mapping it to the CAPE ratio · Why rebalancing builds wealth · Where to look instead · FAQ

What is the most common asset allocation mistake?

In our experience the biggest error is not picking the wrong share. It is over-allocation: holding far more in shares than your situation or the market's valuation justifies.

It usually happens in two ways. First, people delay investing because markets feel volatile, then rush in all at once when things look calmer, which is often after prices have already risen. Second, people delay rebalancing because they believe the market has further to run, so they want maximum exposure right up until the last moment. Both come from the same place: trying to maximise returns right now instead of thinking about returns over time.

The trouble is that nobody picks the top, or the bottom, every time. We cover why in why market predictions fail investors. A rule takes that guesswork out of the decision.

What was Sir John Templeton's dynamic allocation rule?

Templeton built his approach around a simple idea: buy when others are despondent and be cautious when others are euphoric. His dynamic allocation rule, described in Templeton's Way with Money by Alasdair Nairn and Lauren Templeton, turned that idea into numbers.

The starting point is the normal zone. When a market trades at its long-term average valuation, a foundation allocation of 60% in shares and 40% in bonds applies. Because shares and bonds have historically tended not to move together, that mix has delivered smoother returns over the long run than shares alone.

From there, the allocation moves with the market:

• As the market rises above its normal level, the share allocation steps down.
• Once the market trades more than 60% above normal, the share allocation falls to zero.
• As the market falls below normal, the share allocation steps up.
• At 30% or more below normal, the share allocation can rise as high as 100%.

The beauty of the rule is that it forces you to do the uncomfortable thing. You sell some of what has gone up and buy more of what has gone down, which is the opposite of what most investors feel like doing at the time.

How does Templeton's rule translate to the CAPE ratio?

Templeton talked about the market being above or below its "normal" level. A practical way to measure that today is the Shiller CAPE ratio, which compares the market's price with its average inflation-adjusted earnings over the past ten years. If you are new to it, our guide Is a Stock Market Crash Coming? explains how it works.

The long-term average CAPE for the US market sits at roughly 16 to 17. Taking 17 as normal, here is how Templeton's steps line up.

On those numbers, Templeton's zero point arrives at a CAPE of about 27. The US market's CAPE is currently around 42, roughly 147% above normal. On his framework, he would hold no US shares at all.

That is a striking conclusion, and it is worth being clear about what it does and does not mean. It is not a prediction that the US market will crash next month. Expensive markets can stay expensive for years. What it does tell you is that the odds of strong returns from today's US prices over the next decade are poor, and that history has not been kind to people who bought heavily at valuations like these.

Why does rebalancing matter for building wealth over time?

Rebalancing is simply asset allocation at a different point in time. You set a target mix, and when markets move you away from it, you bring it back. In practice that means trimming what has run hardest and adding to what has lagged.

It matters for three reasons.

It protects what you have already built. The maths of losses is brutal. A 50% fall needs a 100% gain just to get back to where you started. Reducing exposure as valuations stretch means you have less at risk when the inevitable correction comes. We explain this order of thinking in the risk hierarchy.

It gives you something to buy when prices fall. Investors who are fully invested at the top have nothing left to put to work at the bottom. Rebalancing builds that reserve automatically.

It takes emotion out of the decision. When markets are booming, every instinct says hold more. When they are falling, every instinct says get out. A rule gives you permission to do the opposite, which is usually the right thing over long periods.

This is why we push back on the idea that time in the market is all that matters. Time matters, but so does the price you pay when you start. We look at the history of buying at market peaks in timing the market or time in the market, and the idea that markets drift back to their averages in mean reversion.

If the US is expensive, where should investors look?

Templeton's rule applied to one market does not mean stepping out of every market. Valuations differ enormously around the world, across asset classes and between sectors. Historically, markets bought at a low CAPE have gone on to deliver higher returns over the following decade than markets bought at a high one.

That is why our general approach is to focus on the asset classes, countries and sectors that are still cheap, rather than following the crowd into whatever has done best recently. The same discipline applies to property. In Australia, the price-to-income ratio plays a role similar to the CAPE ratio for shares, and it is sitting well above its long-term average. We compare the two in our stocks vs property guide.

None of this is about calling the next move. It is about tilting the odds in your favour over years and decades, which is how wealth is actually built.

How TMM helps investors build wealth over time

Our work with clients is built around the Three Wells framework. Well One focuses on capital protection: understanding drawdowns and how much of a fall a portfolio can absorb. Well Two focuses on valuation and global rotation: using measures like the CAPE ratio to identify which countries and sectors offer better value. Well Three focuses on long-term structural wealth, including super and the power of compounding over decades.

Rather than handing over a one-size-fits-all model, we spend 12 months getting to know each client and their goals, then help them build and structure a portfolio drawing on all three Wells, with one-on-one support along the way. The aim is simple: a portfolio you understand, built to handle expensive markets and cheap ones, so you can keep building wealth with confidence over time.

If you would like to hear more of this thinking first, Steve, Tom and Jacob discuss it every week on the Signals & Noise podcast, and the full show notes for this episode are free.

Frequently asked questions

What is dynamic asset allocation?

Dynamic asset allocation means adjusting how much you hold in each asset class as market conditions change, rather than keeping a fixed mix forever. Templeton's version links the share allocation directly to how far the market trades above or below its normal valuation.

What is a normal CAPE ratio?

The long-term average Shiller CAPE ratio for the US market is roughly 16 to 17. Readings well above that suggest the market is expensive relative to its own history, and readings below it suggest the market is cheap.

Would Sir John Templeton be out of the market today?

On his dynamic allocation rule, applied to a US CAPE of around 42 and using 17 as normal, the US market would be about 147% above normal, well past the 60% level where his share allocation fell to zero. That applies to the US market specifically, not to every market worldwide.

How often should a portfolio be rebalanced?

There is no single right answer. Some investors rebalance on a calendar, such as yearly, and others when an allocation drifts a set amount from its target. What matters most is having a rule and sticking to it. This is general information only, not a recommendation for your situation.

Should I sell all my shares if the market is expensive?

This isn't personal advice, and TMM doesn't tell anyone what to buy, sell or hold. Our content is general education only. Always consider your own circumstances and speak with a licensed adviser about your specific situation.

Keep reading

• Is a Stock Market Crash Coming? What History Actually Tells Us
• Timing the Market or Time in the Market?
• Mean Reversion
• The Risk Hierarchy
• Stocks vs Property in Australia (2026): The Wealth Guide

This newsletter is for informational purposes only and does not constitute financial advice. Total Money Management | AFSL 568642.