After last week’s post about Techno stocks being the new dividend favorites,Charlotte mentioned that she was too old to invest in the stock market. I found this comment intriguing as I just met an 85 year old investor who still has about 20% of his portfolio in stocks…. And I’m not considering the amount he has in preferred shares! He was pretty happy with his portfolio and liked the fact that he could beat the inflation. If this investor doesn’t follow the 100 minus your age rule of thumb for asset allocation, why should you?
Age Doesn’t Matter and This 100 minus Your Age Rule is Bogus
When it’s time to invest, I don’t think that age should be a factor. Not today anyways. There is a weak rationale behind the famous rule of thumb where you should subtract your age from the number “100” in order to get your ideal proportion of equity in your portfolio. The main idea behind this rule of thumb is that the older you get the more likely the chance you will need to withdraw from your investment to support your lifestyle. Therefore, if you are making monthly withdrawals from your investments, it’s logical to think that you don’t want to go through market variations that would affect your withdrawal capacity. On the other hand, a young investor in his 30’s can take a lot more risk since he has several years in front of him to recover his losses before withdrawing his capital.
So far, so good. The rule makes sense and it’s hard at this point to say that it’s a bad investment strategy. However, it is a bad one. Here’s why.
#1 Consider Your Personal Situation First
Ideally, we would be able to hold our emotions and look at our personal situation with pure rationale. Imagine that you are a young entrepreneur in your 30s. You have invested most of your money into the business and are working very long hours. After a few years, you start to make money and can invest your savings. Since you go through good years and bad years with your company and haven’t see such important growth in the stock market as compared to your business, do you think you would invest 60%-70% of your money in stocks? The answer is most likely not. Entrepreneurs like bonds and safe investments because they simply want to protect their savings from inflation. They will get their growth from their business. This is where they take most of their risk.
A similar thinking can be applied to several high paying but unstable jobs. Positions like high level management (Regional Directors, VP’s, etc) or in sales (with a big portion of income as performance bonuses) have a similar pattern. You can make a lot more money with your performance bonus than you can earn from your investment returns. Therefore, you are better off investing your money safely. You can also put the self employed into this category too.
On the opposite side, if you are working for the Government and have a defined benefit pension plan, chances are that you can take some risk in your personal retirement account (Roth IRA or RRSP in Canada). At retirement, you will be 100% assured to receive your pension. Why not try to get some growth from your investments? After all, you don’t really need them to live.
#2 Consider Your Needs
I once met with a young investor that was earning a lot of money and had concentrated on paying off his debts already. Therefore, he was in his 40s, living a simply lifestyle, being debt free and earning 250K+. Does he really need to generate more from his investments? It was totally useless for him to take risk as he didn’t need more money than what he already had. All he needed to do for his retirement plan was to beat inflation.
On the other hand, if someone that is 55 and has never saved a penny, he will need to take more risk with his investments if he hopes to retire at 65 with some kind of decent pension. A 2-3% investment return won’t be sufficient and will need to aim for at least 5-6%.Therefore, he would probably need to invest 70% of his portfolio in equity in order to realize such returns as compared to a 45% and less if he would follow the rule of thumb.
#3 Consider Your Emotions
The first two points show you how you can manage your asset allocation if you had no emotion. The problem is that we are human and can’t just invest our money according to a solid investment strategy and ignore market fluctuations. Some of us are more sensitive to paper losses and should definitely avoid them. I’ve seen too many people freaking out and lacking sleep because of the stock market roller coaster. I always say that the best investment strategy is the one that lets you sleep at night. Regardless your age, you are allowed to like risk or not.
What’s the Ideal Asset Allocation?
There is no answer to this question. Like I said, you should invest the way you are comfortable with. But here’s a trick. If you think the stock market is risky, this is probably because you don’t understand how it works. Education is often the solution to resolving a fear of something. When you learn how it works, you won’t be afraid that the stock market would collapse completely and that your investment would go down to 0. If it ever happens, there will be a good news; gas would go down to a few pennies J. So if you don’t think that gas will hit a dollar per gallon, you should probably shouldn’t think that the stock market will collapse!Google+