What is age-based asset allocation?
Age-based asset allocation is an investment strategy in which your age determines your mix of stocks and bonds. When approaching and then entering retirement, you will supposedly need more income to offset lost wages and less future growth since you will have, well, less of a future.
While formulas vary, a typical age-based asset allocation might have you subtract your age from 100. That number gives you the percentage you should invest in stocks; the rest would go into bonds. For instance, if you are 30 years old, you’d put 70% of your money in stocks, 30% in bonds. If you are 80, put 20% in stocks and 80% in bonds. This sounds simple and perhaps logical. It certainly is simple. It is also ignorant and irresponsible.
Why you should avoid age-based asset allocation
It ignores risk tolerance
There are nervous thirty-year-olds who would not be comfortable with most of their money in stocks. There are eighty-year-olds who want maximum asset growth. Age-based asset allocation ignores a basic precept of proper investing: maximize return at a level of risk appropriate to the individual. Most large financial firms provide detailed questionnaires to their reps to help them determine client risk profile. It’s a foolish rep who ignores these questionnaires to rely on client birthdays.
It ignores demographics
Life expectancy grows as you age. If you reach age 60, it is likely you will live beyond 80. At 70, you will probably make it past 85. The average investment cycle, a period of time over which stocks and bonds typically go through bull and bear cycles to attain their long-term rates of return, is around seven years. So even at 70 you’ll likely experience at least two complete investment cycles. Unless you have an extraordinarily conservative risk profile, you’d be foolish to hinder decades of returns with a portfolio excessively weighted in bonds.
It ignores family
Unless you expect to spend every last penny and pass nothing to heirs, their life expectancy is more important than yours. In wealthy families, elders don’t dump stocks to generate income and stability. Handled correctly, their portfolios are well-managed through life and the lives of succeeding generations.
What you should do instead
Invest with logic, not a calendar. Ignore your birthday. Do not ignore bills. Make sure you have enough cash to cover your likely expenses over the next few months.
As for the rest, allocate assets among stocks and bonds in accordance with your tolerance for risk. Click here for a proper regimen, including help in estimating your tolerance for risk as it pertains to asset allocation.
* Data source:
U.S. Department of Health & Human Services; National Center for Health Statistics