By David McEwen
Saturday 24th March 2001 |
Text too small? |
"`That kind of money is pretty hard to make up,' said Haggert, 50, as he made deliveries in his mail truck to homes in Avon, Ohio. He'd planned to retire in five years. Now he figures stock losses may tack an extra three years on to his career."
This snippet from a recent news item offers a classic example of why the risk profile of portfolios should be adjusted regularly according to personal circumstances.
Many people start investing in the share market or in managed funds when they are in their 20s or 30s and keep putting in regular amounts for their entire working lives. The idea is that by the time they retire, they will have enough saved up to provide a comfortable income.
Unfortunately, it is not as simple as that. Good investment portfolios are made up of a variety of asset classes, from property to government stock to shares. Each asset class has its own risk/return ratio and these need to be accounted for as you age. Regrettably, there is no way of getting
more return without an increase in risk.
Shares, for example, generally provide excellent returns over time, but their values can fall as well as rise. People with plenty of time to accumulate wealth can afford to wait for things to turn around if their shares go down in value, but not those who need cash to live on now.
Let's divide the average human life into three ages, youth, middle and 'golden'.
In the youth stage, there probably isn't much ability to save as most of the time is spent in education. However, what can be saved should be invested mainly in high return/high risk assets. That's because there is plenty of time to weather those periodic economic and market downturns.
In the middle age, incomes are higher and, once mortgages and children have been sorted out, there should be plenty going into investments. Again there are still decades left to deal with any unexpected barriers to wealth appreciation, so a high proportion should still be invested in those higher returning assets. However, there is less time so some capital preservation plans need to be kicked off, generally by putting more into stocks and bonds.
By the time the golden age of one's life comes along, retirement is looming and it would be financial suicide to have a large percentage of one's wealth in highly volatile assets. Income is the main goal and it is worth sacrificing potential capital gains to lock those cash flows in. By this time only a fraction of the portfolio should be in the riskier asset
classes.
That's not to say investors should sell out of investments such as shares entirely. These days people can expect 20 years of retirement and a fixed capital base often won't stretch that far.
It makes sense for people to reduce the riskiness of their investments as they get closer to retirement. If they don't, they may end up like poor Mr Haggart and be forced to keep on working for longer than they expect.
David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.
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