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Getting older? Admit it when you rebalance your portfolio

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

You’re not getting any younger!

This can be painful stuff. It’s bad enough remembering your own mortality when trying (/squeezing) on new jeans or racing your kids around the park.

But the fact is our ideal asset allocation will likely change as we get older, too.

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

The general idea is to shift your asset allocation as you age. As the policemen look ever younger and the lineup at Glastonbury seems ever more foreign, you want to have ever less of your money in higher risk assets such as shares, and more in lower volatility assets like bonds.

This is not because of the increasing risk of having a heart attack if the stock market crashes.

It’s that you’ve less time left to recover from such big falls.

You’re closer to needing to spend your money. Or to be blunt not needing it at all.

How low can you go?

Conventional investment wisdom doesn’t suggest you completely abandon equities as you age. Diversification is still valuable, even if you’re more an old rooster than a spring chicken.

Shares offer some protection from higher inflation over the long term, as well as hopefully stretching your funds a bit further. A 70-year old can expect to live for another 15 years, and a sizeable number will live much longer than that. That’s still well within the time horizon for reasonably expecting decent returns from shares.

Of course we don’t know exactly how long we’ve got, which is what makes all this much more complicated than it would otherwise be. The best we can do is muddle through (and remember that Logan’s Run didn’t exactly sell the alternative…)

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!

Actually, as life expectancy has increased, this rule of thumb has been tinkered with. Some people now suggest using 110 instead of 100 in the sums, for instance. But the basic idea is clearly to dial down on shares and add more bonds.

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

Rules are made to be broken

The high yield equity portfolio (HYP) concept is one alternative that was once very popular on UK investing discussion forums.

The idea is you permanently hold a basket of high-yielding blue chips and live off the income. The capital value of the HYP may fluctuate, but the dividend income should be more stable – and potentially even grow – over time.

In recent years, investors seem to have realized they can get similar and probably safer exposure from a basket of well-chosen investment trusts or funds, or even higher-yielding ETFs.

However you do it, the huge downside of trying to live only off the income from your portfolio – besides the uncertainty inherent with shares – is you need a lot more money.

Most people end up with far smaller retirement pots than would be required. So they must work on the assumption that they’ll be selling it off to generate an income.

And it’s the uncertainty of the price you’ll get for your risky assets like shares when you need to sell them that is behind the shift into bonds and cash.

Also, this uncertainty compounds. A few bad years as you approach retirement or early on when you’re spending your portfolio can really knock you back. In contrast a few bad years at the end of your life may by that point be irrelevant, since you have more than enough cash to see you through.

Such sequence of returns risk is intractable. It also leads to survivorship biases. Someone who retired in the mid-1980s will tell you that keeping all their money in shares was a no-brainer, whereas a 2008-vintage retiree may urge you to swap everything for gold the moment you’ve seen your last pay slip.

(Neither is advisable!)

Retirement researchers have begun to suggest in recent years that the optimal approach might be to reduce your exposure to shares and other risky assets as you approach end-of-work D-Day – but then to actually start to add more shares to the mix again as you proceed through retirement.

Have a read and see what you think. I think the maths – and to an extent the logic – makes some sense. But I’d be concerned at betting my one-shot at being retired on a new theory that could be distorted by how returns have played out in the past. The future could be different.

We know that cash and bonds – and annuities for that matter – are relatively lower-risk. Shares can always crash 50% or more in a year.

If you can afford to, I think it makes sense to build the core of your retirement plan around the closest thing we get to knowing in investing.

Live forever?

As Lars Kroijer has pointed out on Monevator, if you’re rich things may be different. Your time horizon may extend beyond your own needs – and your death – as you look to provide for a partner, an estate for your loved ones, and even a trust or bequest for a cause you believe in.

The very wealthy can create a super-safe income floor from low-risk assets. They can then keep the rest in higher-risk investments like shares, property, and the illiquid assets so beloved of the truly loaded, such as forests, paintings, and copper mines in the Balkans.

You’ll need to pony up for advice on how best to do all this, though.

Age and rebalancing your portfolio in practice

However you decide to change your asset allocation as you age, re-balancing time is the ideal opportunity to put it into practice.

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

With the equity portion likely to grow over time and the bond portion comparatively static, this means such investors become much more exposed to equities as they get older. As we’ve discussed, the accepted view is they should become less exposed!

Regular rebalancing at least avoids your portfolio becoming ungainly – and excessively risky. But by making small incremental shifts to our asset allocation over time, we can also tilt towards our desired long run asset mix.

We run our Slow and Steady model portfolio this way, shifting 2% of our equity allocation to bonds every year, regardless of what the market does.

Running your own age-related lifecycle fund

Target date or lifecycle funds are funds that rebalance portfolios as the owner ages.

They’ve become popular in the last few years, and they promise to mimic what a wealth adviser would do to a client’s portfolio, by 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 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, then your regular rebalancing could take this into account.

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, then rebalancing to 40/60 in favor of bonds on your 60th birthday.

This could be a particular apt strategy if you’re keeping things very simple with Vanguard LifeStrategy or similar auto-rebalancing funds. But personally, I’d favor a more gradual approach.

What if there’s been a huge bull market in shares and you’re getting very close to retirement?

An investor who was approaching retirement in 1999 would have done very well rebalancing towards bonds just before the dotcom crash. In contrast, an investor of the same age who got greedy and kept running up the equity position could have ended up much poorer.

This is straying into active investing territory. Readers may recall I frolic in it personally, but most people (and who knows, maybe me) would be better off following my co-blogger’s purely passive lead.

That’s because is it’s very hard to know when you’re in a truly overvalued scenario. Most purported bubbles are just normal bull markets.

Even missing the early years of what turns out to be a bubble can be detrimental.

If an investor had got nervous in 1996 and sold down his equities, he’d have missed out on much of that great bull market. If he then threw in the towel – and all his money – in 1999 by buying far more shares late to try to make up the difference, he could have blown up his retirement pot permanently.

Following rules doesn’t remove all the risk, but it does lessen the risks of poor judgement and making mistakes.

Age is more than just a number

Ultimately you must make your own decisions about how age affects your rebalancing.

Whatever you decide, just don’t pretend you’re Peter Pan. And remember too that getting old may well reduce your ability to juggle assets like a hedge fund manager on Billions.

True, there are some great old investors. But the consumer watchdog shows are also stuffed with elderly people who fell for nonsense scams.

One more somewhat depressing reason to reduce risk in your portfolio as you get older.

Series NavigationFactors that may influence how and when you rebalanceRebalance your portfolio for your benefit, not the tax man’s

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{ 21 comments… add one }
  • 1 John B June 8, 2017, 12:51 pm

    A lot depends on how close to the wire you are running your FIRE plans. If you think you’ll only just reach your minimum level X, be cautious. But you might be better aiming for 1.3X by staying in equities longer which would give all that discretionary spending on fun, and give a good buffer if the market did have a poor sequence of returns. It gets ever more expensive hedging against the last 20% of bad scenarios, and you might be missing out on the great returns in 40% of scenarios. Adjusting your spending with market conditions to keep at the 1.1-1.5X level could be beneficial, as who’d want to be in bonds now whose return is often negative.

  • 2 AtlanticSpan June 8, 2017, 1:12 pm

    I’m 61 and I have gradually reduced the complexity of my portfolio.I use the Vanguard 40/60 LifeStrategy Fund as the core of my holdings. For a little ‘excitement’ I own a 100% global equity fund to keep my interest up!

  • 3 hosimpson June 8, 2017, 2:02 pm

    It probably also depends on how long your retirement is going to be. All mainstream advice I’ve heard has assumed a 20-25 year retirement. I’m hoping to retire when I’m 46ish, and have no intention of departing this life at 66. I recon the longer one hopes to stay retired the higher the allocation of equities?

  • 4 Clive McGovern June 8, 2017, 2:41 pm

    One point that might be worth making is that life expectancy is increasing and so the traditional view of moving into lower risk, lower return investments as one approaches retirement is not necessarily as sensible as it once was. Beyond having an income floor (to ensure the basics are covered on an inflation linked basis for the rest of one’s natural) it also seems to me that remaining substantially invested in equities post-retirement also makes sense if you are going to live for 30+ years in retirement. The extent to which you balance asset classes at and beyond retirement, assuming reasonable health at that point, is more a function of excess funds over the income floor than it is purely about age.

  • 5 october June 8, 2017, 2:56 pm

    Interesting piece in last weeks ic by Chris Dillow: ‘Lifestyle investing as a legacy idea’

    I am currently approaching retirement and am struggling a bit with Bond Allocation.(I only have cash and equities) I want an easy option and am on the point of increasing my bond holdings by settling on say, one of Vanguards’ Lifestrategy funds when… ‘the more I read the more confused I get!’

    Also when you read Accumulators comments on Tim Hales 3rd edition in an article on 19 Nov 13 and read :-

    ‘First edition Smarter Investing

    The main reason to read the 1st edition is for several lost passages on the behaviour of UK bonds between 1900 and 2004.

    My hair does a Van de Graaf every time I see the -74% real loss of the 1900s or the -73% shaft on the graph that is the 1940s.

    More chilling still is the -4% real loss p.a. that occurred over the worst 30 years of UK bond investing history or the 47 years it took to recover the real purchasing power of your bonds lost during the bear market of the 1940s to 1970s.

    It’s a graphical insight into the havoc that financial repression and inflation can wreak upon bond investors – a topic with particular resonance today.’

    In today’s climate is it better for someone approaching retirement to hold short term bonds only (or maybe none at all?), despite the miserly returns that are getting whacked by inflation?

  • 6 dearieme June 8, 2017, 3:00 pm

    “life expectancy is increasing”: I think you’ve got the wrong tense there. Over the past thirty years it has increased. Over the past two or three it perhaps hasn’t. Our interest is in the future, about which we can only guess.

  • 7 Clive McGovern June 8, 2017, 3:16 pm

    dearieme

    Life expectancy, like investment is all about probabilities. Whilst we can’t know the future of course, for financial planning purposes the probability is that life expectancy on average will increase in the future as medicine advances to cure or limit the big killers (cancer, cardiovascular disease etc). The probability of a longer life has implications for the required post-retirement investment returns and hence portfolio mix; putting it all in bonds at 60 may not be the best idea IMHO!

  • 8 Scott June 8, 2017, 5:10 pm

    As mentioned be a couple of previous commenters, a lot depends on age at/possible length of retirement. Having FIRE’d at 42, I wouldn’t be keen on holding nearly 60% of my worth in bonds (or cash, for that matter.)
    I have a buffer to cover me for a few years, with the rest in equities. I’m expecting a defined benefit pension at 60, so don’t need to make my portfolio last a lifetime, and I feel I’m young enough to take a job should the markets be in turmoil when I’ve run out of cash, thus avoiding the need to sell equities at a low.

  • 9 Jim McG June 8, 2017, 5:30 pm

    I’ve thought a lot about this subject recently, partly because my saving and pension funds have had such a good run. They’re about 80% in equities and I’d like to protect the gains. I’m 18 months away from hitting 55 but increasingly I feel it’s unhelpful to imagine a “finishing line” where I need to take action, such as cashing in a 25% chunk of the pension pot tax free on my 55th birthday. Who knows if that will be an opportune time to do so? So I quite like the suggestion of having a 50/50 portfolio at 50 years old, and a 60/40 one ten years later, maybe rebalancing each year. That would mean aged 55 I should be 55/45 in allocation. Then I’d just draw down pension money as I need it. I’m going to think about that.

  • 10 The Investor June 8, 2017, 7:20 pm

    “…putting it all in bonds at 60 may not be the best idea IMHO!”

    Hi. Sorry if this seems pedantic, but I always feel the need to jump in when readers say things like this — which strangely they always seem to say about *bonds*. 🙂

    Nobody is suggesting “put it all in bonds”! The rules of thumb cited in the article would imply either 40% or 50% in equities and the rest in bonds. So a 50/50 equity/bond split would be well within much mainstream thinking, at 60.

    Re: More generally, I do talk extensively about holding substantial equities in retirement… and for more on holding an *increasing* amount of equities, follow the “have a read” link.

    Cheers for comments!

  • 11 The Investor June 8, 2017, 7:22 pm

    @October — Bond returns are low, but that’s just an accident of the time you happen to be in, not a change in the riskiness of bonds versus equities, at least from a passive perspective.

    That said I think a private investor choosing to holding a big slug of cash instead of bonds today as part of their fixed income allocation can make sense, and it’s certainly where I am personally. (I am far from retirement though, and please don’t take that as personal advice, which I can’t give).

    Remember that you won’t get any counter-cyclical moves with cash that you might get from government bonds if shares crash in an unexpected recession or whatnot. But of course cash won’t fall in nominal terms, either.

    For more you might try these long recent articles by Lars:

    http://monevator.com/what-is-the-minimal-risk-asset/

    http://monevator.com/should-you-invest-in-short-or-long-term-government-bonds/

  • 12 dawn June 8, 2017, 7:41 pm

    mmm its just that bonds are so rubbish and cash barely keeps up with inflation.
    I like this…. ‘ never be more than 75% or never less than 25% in equities at any one time.
    when to sell down??
    Morning star have an article about this and it is suggested its should now be other way round! where you keep your equity level high’ not bond level high, throughout retirement.

  • 13 Rob Ashton June 9, 2017, 6:15 am

    I am constantly toying with rebalancing but have not done it yet because I keep reading that Bond markets are in a bubble and when interest rates go up the price will collapse or at least head south. What am I missing between urged to rebalance on the one hand and being told on the other hand that bonds are at an artificially inflated level because of ‘QE’?

  • 14 Alistair W June 9, 2017, 9:38 am

    The rebalancing question is one that has been on my mind for a while, as someone who is currently all-in on the Vanguard Lifestrategy 20. Whilst retirement is a long way off for me, it strikes me that tweaking one’s asset allocation with the Lifestrategy funds is not so easy, but perhaps not impossible. If I hold the Lifetstrategy 20 and the 100, can I make subtle tweaks by adding-to/drawing-down from one or the other as appropriate? Anyone else do this? Unfortunately it’s not perfect, as there’s no Lifestrategy 0. It would be great if Vanguard would introduce this and allow individuals to choose their own allocation.

  • 15 dearieme June 9, 2017, 2:10 pm

    “medicine advances to cure or limit the big killers (cancer, cardiovascular disease etc).”

    Maybe, but most progress on cancer has been on childhood cancers whereas for pensioners what matters is life expectancy at about age 65. Meantime, in Britain CVD has moved from killing lots of men in middle age and early old age, to mainly killing codgers. I shouldn’t be surprised if that move is a large part of the explanation for the greater life expectancy over the past generation. But if (as some people conjecture) CVD was an infectious disease against which people have now got improved immunity, then there’s no reason to think that this cause will continue to extend lives. Further, there’s no evidence that medical advances have done much to defer CVD to old old age. Cessation of smoking probably helped but that has little room left for improvement, I’d think.

    Meantime there’s always the risk of antibiotic-resistant bacteria, plus the perpetual risk of a lethal viral epidemic. “Spanish flu” happened a century ago, and our protection against viral diseases still leaves plenty to be desired.

    I don’t think that essentially mindless extrapolation of trends is a good basis for planning to defend oneself against future possibilities.

    “Life expectancy, like investment is all about probabilities.” I suspect that the risks are more a matter of uncertainty than probability.

  • 16 PinchThePennies June 9, 2017, 2:32 pm

    @Alistair W,
    A Lifestrategy 0 fund would be a fund holding bonds only and no equities at all. This is already available from Vanguard although not under the LS name:

    https://www.vanguardinvestor.co.uk/what-we-offer/all-products

    Look at the Fixed Income section – lots of Bond funds and Bond ETF’s available. Pick & Mix to your hearts content!

    Should you decide you do want to add equities you then have your pick from the other funds and ETF’s on offer by Vanguard or simply go with LS100 to balance your Bonds. Any rebalancing of your desired split would have to be done manually.

    I think that there was an article on here once about using either LS80/20 and LS20/80 (or 60/40 and 40/60) in tandem to fine-tune allocations to equities and bonds but I can’t find it at the moment.

    Regards, Pinch

  • 17 Alistair W June 9, 2017, 4:39 pm

    @PinchThe Pennies
    Thanks for the suggestion, although I don’t think it provides the solution. The Lifestrategy funds are meant to be a ready-made pick-and-mix of the various individual Vanguard funds. Whilst you’re quite right that I could create my very own ‘Vanguard 0/100’, this would require buying into at least eight separate vanguard fixed income funds, which rather defeats the whole point of the Lifestrategy route. In an ideal world one would only invest in two funds: a diversified and indexed bonds fund, and a diversified and indexed equities fund. i.e. a Lifestrategy 0/100 and a Lifestrategy 100/0. As far as I know this is not currently possible to do, but I would love to be mistaken.

  • 18 Mr optimistic June 9, 2017, 9:09 pm

    At 63 trying to learn from LK but finding pyschologically hard to buy govies at these yields. Also worried about selling down when you have multiple holdings in multiple accounts. Have fastened on to HSBC Global Strategy Cautious account as a possibility. This was reviewed here sometime back, think it could benefit from another look as I think they must have reduced their charges 🙂

  • 19 Naeclue June 10, 2017, 9:32 am

    For those reluctant to buy bonds “now” I would like to point out that, having held an allocation to gilts for over 20 years, in all that time the future return on gilts has never looked good.

    The returns on bonds only look good with the benefit of hindsight and this will be true again the next time we get a stock market crash or prolonged bear market.

  • 20 Mr optimistic June 10, 2017, 12:38 pm

    Thanks! Incidentally, re discussion on life expectancy, you can download the interim life tables from the gov site. Note that these lag, ie the statistics for 90 year olds must be based on people born in the early twentieth century so the benefits accruing to health are feeding through. Guess life companies have sophisticated models to extrapolate the data to get better data.

  • 21 dawn January 15, 2018, 7:57 pm

    Im planning on living off my personal pension [which im moving into a sipp soon to reduce charges] and cash savings from 55 to 67 yrs which will be in about 28 months
    At present its a 30% equities 70% cash split. My plan is to use up this money within 15 years starting in 28 months time.
    Is that split about right ? I could ride out a crash for 3-4 years and live off the cash but what worries me is the market crashing and not recovering for 10 years, once in the new sipp ,when i rebuy , i could rebalance but id have to buy a bond etf [vanguard] so could increase safe asset class. 3-4yr crash wont bother me but a 10 yr one does! a few people Ive spoken to tell me it took them 10 years to break even again with equities!!! any thoughts??

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