Age is just a number. Whilst it’s certainly not a meaningless number, when it comes to your investment asset allocation decisions, it shouldn’t be the only factor you consider. Asset allocation is the mix of equities, fixed interest securities, cash and other securities that makes up your investment portfolio. Selecting the appropriate asset allocation mix for your portfolio is an important decision to make, and different investment managers, financial professionals and individuals may have varying methods on determining it. A popular method is based on your age. Some might suggest subtracting your current age from another number (such as 100) to determine what percentage of your portfolio you should have in equites. Or they may simply state that a 65-year-old should have a certain amount in equities, but a 75-year-old should have a different certain amount in equities, and so on.
However, we don’t believe these simple rules of thumb are optimally aligned for your investment goals and objectives. Sure, it is easier for financial professionals to base their entire recommendation on one simple factor—age—but is it the right way to do it? Is simpler better in the case of determining the asset allocation for the investments you will need in retirement? Let’s consider the case of two individuals with the exact same age and exact same amount currently saved for retirement.
John and Robert are both 65 years old and have the same size portfolio. John is a widower, and has one son who is in his 30s. His son is independently financially successful, and does not require any financial assistance from John now, nor does he expect to in the future. John’s parents passed away in their 70s. John himself has had two heart attacks. John needs his money to be a primary source of income during his retirement, but does not need to plan to leave much left over.
Robert is currently married, and his wife is 10 years younger than he is. Robert and his wife have two children, both of whom occasionally get financial assistance from Robert. Robert has several sources of income other than his investment portfolio that he is planning to draw from during retirement. Robert’s parents lived until their 90s, and he has not had any major health problems. Robert would like his portfolio to be able to help support both him and his wife throughout his entire retirement, his wife after he dies, and potentially his children as well if they need it.
These two investors are the same age, with the same amount saved for retirement, but are in very different situations. Does it really make sense for John and Robert to have the same investment portfolio? They need their money to do different things. They have different life expectancies, different family situations, and different goals for their money, but overall each set of circumstances is not uncommon. Many individuals may find themselves in situations similar to John or Robert, somewhere in between the two, or maybe even an entirely unique situation!
So should age really be the most important thing that matters? Age can certainly be a factor, but in our view, it shouldn’t be the only one or most important one.
So what’s a better solution? We believe you should take a more holistic view of your situation when selecting your asset allocation. Think about what you actually need your portfolio to do over the course of your retirement. Three important things to consider are your investment time horizon, your return expectations and your cash-flow needs.
Your investment time horizon is how long you need your assets to provide for you. Some investors misinterpret this to directly relate to their age. However, your investment time horizon is not your current age and not your planned retirement age, but the amount of time you will need your money to provide for you, and possibly a younger spouse or your dependants. Your current age can play into it, but you also need to consider your life expectancy—based on your personal health, things such as your parents’ lifespans and also lengthening lifespans overall due to medical advancements. If you have a younger spouse, or dependants you plan to support, you’ll need to account for how long they’ll need the portfolio as well. Your investment time horizon could be 5, 10, 20, 30 years or even longer! It is something you need to evaluate for your personal situation.
Return expectations also tie into your personal needs. Some investors want true capital preservation—they want to keep the amount they have and risk nothing, even if it means they will get no growth to match inflation or meet long-term needs. However, many investors need some growth, whether that’s to provide cash flow later on in retirement, to grow to meet rising costs over time, or perhaps to grow the portfolio to an amount they wish to leave behind to beneficiaries or charity. Think about what growth your portfolio may need to provide in order to meet your needs.
Finally, cash-flow needs are an important factor to consider. Do you plan to use your investments to cover necessary living expenses? Most retirees do! How much will your portfolio need to support? Do you plan to rely on your investments for day-to-day needs, or will it just be supplementary to other income sources? And if you don’t plan to use your investments for any cash flow in your own retirement, that’s important to know as well.
Once you’ve considered these factors, you should have a better idea of what your portfolio needs to provide for you, and how to position your asset allocation for what you need. Selecting your asset allocation is a serious decision. Improperly selecting it or changing it can have repercussions that can be difficult or impossible to correct. Overall, age can factor into your investment time horizon, but it likely is only one piece of the puzzle.
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