Monday, 9 May 2016

Age of rule thumb - Asset allocation



The popular "age of rule thumb" states that a portfolio should get more conservative as a person gets older.  For example, a 30 year old with several years of investing and earnings ahead of them should allocate about 30 percent of his or her portfolio to fixed income and the remaining 70 percent to equities which have a higher risk, but potentially higher returns.

An 80 year old on the other hand would have, who can not afford to take much risk should allocate 80 percent of his or her portfolio to bonds or guaranteed investment certificates and just 20 percent to equities.

This is an easy rule to follow and maybe at one point it made complete sense.  It has survived all these years as a guide which to me should not be carved in stone.  It can be changed or modified to fit today's investor.  Today's investor are retiring earlier and living longer, thanks to better health care and nutrition, their money must last longer also.  That's is why the age of rule thumb to me is way too conservative.

In today's financial world, the proper asset allocation will always be talked about and discussed.  Maybe it should start with this rule or maybe it should not.  But to most investors, it is what allocation they are comfortable with, they must know the risks to make an informed decision.  To pigeon hole them into this type of asset allocation without options to me seems, wacky.  Yes wacky.  There are old standbys and traditions in the financial world of investing that just seem wacky.  Why do people follow what was done in the past?  Does it make it right for today's world?  Think about it, would I call you from a rotary phone or would it be obvious to call you from a cellular phone?  Kinda the same there here, would I follow the same asset allocation as my grand parents?

Modification to Age or rule

Why not multiply the person's age by one one-hundredth of their age and capping the fixed income percent at 50?  For example, a 40 year old would have 40 times 0.4 or 16 percent in fixed income.

A 70 year old would have 70 times 0.7 or 49 percent in fixed income.

Anyone older than that should have a 50-50 mix.

There are other factors like how much will an investor need to withdraw from their portfolio.  If a retired investor is withdrawing about 7 percent a year from their RRSP, they would need to take that into consideration.

A wealthy investor who lives off the 1 percent of their assets can afford to invest in more equities than the previous example.

Health also need to be a consideration, if you sense that you are going to live longer, then you need to make sure you have enough money to last all those years.

There you have it, my views on a modified formula to determine asset allocation of one's portfolio.

It is not as easy as plugging in numbers into a formula but now you can make a more informed decision about your asset allocation.

Please leave any questions or comments