Equity Allocation Revisited
I have written often in this blog how one of the most important investment decisions you must make is selecting your appropriate equity allocation for your retirement portfolio. In my discussions on this topic, I have referenced a simple equity allocation guideline, “100 minus your age,” people can use that I first explained in this post. Recently, a friend told me they read an article by a financial planner recommending that this guideline should be changed to 110 or 120 minus your age. My friend wanted to know whether I agreed with this change.
The reason many financial planners have recommended this new guideline of “120 minus your age” is because the returns on fixed income investments are currently very low and people today are living longer. The “100 minus your age” guideline was first recommended in the 1950s and 1960s. The average life expectancy then was about 72 to 74 years. Today the average life expectancy for people already in their 50s and 60s is closer to 82 to 84 years. This longer life expectancy would seem to indicate that the equity allocation guideline I proposed should be updated.
The first thing I would say about these guidelines is that they are just that – guidelines. When I suggest people consider the “100 minus your age” guide for selecting your equity allocation, I am only suggesting that people use this guideline as an initial starting allocation if they do not have a good feel for their own risk tolerance. That is, they do not have any idea how they might react to a sudden downdraft in the equity markets like we had in late 2008.
But anyone who uses this guideline to make their initial equity allocation selection should pay attention to the stock and bond market movements. They should try to gauge how they might react to quick upward or downward movements in the market. In other words really try to assess your investment risk tolerance. However, sometimes accurately assessing your risk tolerance is hard to do when you do not have real money at risk. In the 2008-2009 financial crisis many people over-estimated their risk tolerance and could not handle the market chaos.
The suggested guidelines are not important. What is important is everyone, as soon as possible, needs to determine what equity allocation allows them to sleep at night. In early 2008, sensing we were near a market top, I lowered my equity allocation from 50% to 40%. I knew this allocation would allow me to remain calm if the equity markets took a big dip. When the financial crisis hit in late 2008, I re-balanced my portfolio just like any other year. As a result our portfolio was 20% higher in January 2010 compared to January 2008.
We are still in a secular bear market which means we are likely to continue to experience market volatility. My advice to everyone when selecting your equity allocation is not focus on the average annual return that you have determined is necessary to retire. Until we are out of this long term bear market, I would let your risk tolerance determine your equity allocation.
Did you enjoy this post? Why not leave a comment below and continue the conversation, or subscribe to my feed and get articles like this delivered automatically to your feed reader.
Comments
No comments yet.
Sorry, the comment form is closed at this time.