Getting older? Admit it when you rebalance your portfolio

Whether you rebalance your portfolio once a month, year or decade, there’s something else to keep in mind:

You’re not getting any younger!

I know this is painful stuff. It’s bad enough remembering your mortality when shopping for jeans or racing your kids around the park.

But the fact is our ideal asset allocation may change as we get older.

This means your age is another factor to consider when rebalancing.

The idea is to shift your asset allocation as you age so less money is in high risk/return assets like equities (shares) and more is in lower volatility assets like bonds.

The reason for holding safer assets as you get older isn’t because of the increasing risk of a heart attack when the stock market plunges…

It’s that you’ve less time left to recover from big falls in risky assets – you’re closer to needing the money.

Shifting away from equities as you age isn’t a universal rule, though.

The high yield equity portfolio (HYP) concept is one alternative to holding a fixed income retirement portfolio or an annuity. The idea is the capital value of the HYP may fluctuate, but the dividend income will hopefully be more stable, and potentially rise.

Even conventional investment thinking doesn’t suggest you completely abandon equities as you age.

The classic principle governing age and asset allocation is:

Hold 100 minus your age as a percentage in equities
Hold the remainder in bonds

If you were 30, you’d hold 70% equities and 30% bonds in your portfolio.

A 70-year old would hold 30% in equities and 70% in bonds.

I’m not sure what you’re meant to do if you’re 101. Maybe pat yourself on the back and order another whiskey!

Age and rebalancing your portfolio in practice

Shifting your asset allocation over your life is an article in itself, but I mention it here because rebalancing is the ideal time to put it into practice.

Studies suggest that many private investors simply set up their retirement portfolios or other investment plans in their 30s and 40s and never touch asset allocation again.

With the equity portion likely to grow over time (bear markets don’t last forever!) and the bond portion comparatively static, this means such investors become more exposed to equities as they get older. As we’ve discussed, the accepted view is they should become less exposed.

Running your own age-related lifecycle fund

Target date or lifecycle funds are mutual funds that rebalance portfolios as the owner ages. They’ve just become popular in the last few years, and they promise to mimic what a wealth adviser would do to a client’s portfolio, shifting the asset allocation as the client ages to less risky stuff.

If you’re managing your own money, you can do the same thing by rebalancing towards your age-related asset allocation targets over time.

If you know that you want to move from 75/25 equities to bonds to a less volatile 25/75 mix by retirement, your rebalancing could take this into account over time.

You might allow the overall bond portion to rise by 1% a year, and run down your equity exposure accordingly, for example.

Or you might set hard targets, such as a 50/50 split between equities and bonds when you’re 50-years old, rebalancing to 40/60 in favor of bonds on your 60th birthday.

Personally, I’d favor a more gradual approach – unless there’s been a big bull market in shares and you’re getting close to retirement.

An investor who was 58-years old in 1999 would have done very well rebalancing towards bonds before the dotcom crash.

In contrast, an investor of the same age who got greedy and kept running up the equity position would have ended up much poorer.

There are no hard rules about age because nobody knows what will happen in future. If our investor had got nervous in 1996 when he was 56 and sold down his equities, he’d have missed out on much of the bull market. Hindsight is not a strategy that works in investing!

Age is more than just a number

You must make your own decisions about how age affects your rebalancing.

Personally, I’ve decided not to take my age into account until I begin to approach my 50th birthday. Until then, I’d prefer relative valuations between assets to influence my allocation. Doing so, I accept some extra risk.

Whatever you decide, just don’t pretend you’re Peter Pan!