The investor’s lifecycle

The following article on the investor’s lifecycle is an extract from Invest Your Way To Financial Freedom – the new book by popular bloggers and friends of Monevator, Ben Carlson and Robin Powell. Invest Your Way to Financial Freedom is out on 28 September, but you can pre-order your copy at Amazon today.

As we write this book, Ben is feeling very sensitive about an imminent landmark birthday. Robin, meanwhile, would love to be 40 again so isn’t as sympathetic as he might be.

One thing we can agree on, though, is how quickly the years go by the older you become, so be sure to make the most of life whatever age you are.

Even in retirement, most people tend to have some exposure to the stock market. Depending on the actuarial charts you use, current life expectancy in Britain for someone in their mid-40s in 2020 is somewhere around 84 for men and 87 for women. So, if we live to that sort of age, both of us expect to be investing for several decades yet.

Realistically, Ben will be investing for another 40 years or more. In that time he’s expecting to experience around ten more bear markets, about half of which will constitute a market crash in stocks. There will also probably be at least seven or eight recessions in that time as well.

Can he be sure of these numbers? You can never be sure of anything when it comes to the markets or economy, but let’s use history as a rough guide on this.

Over the 50 years from 1970–2019, there were seven recessions, ten bear markets and four legitimate market crashes with losses in excess of 30% for the US stock market. Over the previous 50 years from 1920–1969, there were 11 recessions, 15 bear markets, and eight legitimate market crashes with losses in excess of 30% for the US stock market. The figures for European markets, including the UK, are fairly similar.

Bear markets, brutal market crashes and recessions are a fact of life as an investor. They are a feature, not a bug, of the system in which we save and invest our money. You may as well get used to dealing with them because they’re not going away anytime soon. They can’t go away, because the markets and economy are run by humans and humans always take everything, both good times and bad, too far.

The risk of these crashes and economic downturns is not the same for everyone though. How you view the inevitable setbacks when dealing with your life savings has more to do with your station in life than how scary you think those times are. Risk means different things to different people depending on where they reside in the investor’s lifecycle.

When you’re young, human capital (or lifetime earning potential) is a far greater asset than your investment capital. If you’re in your 20s, 30s or even 40s you still have many years ahead of you as a net saver and earner, meaning market volatility should be welcomed, not feared.

There’s an old saying that the stock market is the only business where the product goes on sale and all of the customers run out of the store. Your actions during down markets have a larger say in your success or failure as an investor than how you act during rising markets.

Down markets lead to higher dividend yields, lower valuations and more opportunities to buy stocks at lower price points. It may not feel like it at the time, but if you’re saving money and putting it into the stock market regularly, more opportunities to buy stocks at lower price points is a good thing.

The problem is during a market crash, it will always feel like it’s too late to sell but too early to buy. If time is on your side, you shouldn’t worry about nailing the timing of your investments, especially during down markets.

The good thing about being a young person is you don’t need to worry about timing the market to succeed. You have the ability to wait out bear markets since you have such a long runway in front of you.

The important thing for you is to keep saving and investing regularly, no matter what is happening in the stock market.

People who are nearing the end of their working lives, on the other hand, are lacking in human capital, but they should, in theory, be sitting on plenty of financial capital. People are living longer, meaning the management of your money isn’t over when you retire.

But you have to be more thoughtful about how your life savings are invested at this stage of life because you don’t have nearly as much time to wait out a down market, nor do you have the earning power to deploy new savings when stocks are down by buying when there’s blood in the streets.

Market risk not only has different connotations depending on where you are in the investor’s lifecycle, but also how your personality is wired. Your risk profile as an investor is determined by some combination of your ability, willingness and need to take risk. These three forces are rarely in a state of equilibrium so there will always have to be some trade-offs:

1. Your ability to take risk involves your time horizon, liquidity constraints, income profile and financial resources.

2. Your willingness to take risk involves your risk appetite. It’s the difference between your desire to grow your wealth and your desire to protect your wealth.

3. Your need to take risk involves determining the required rate of return necessary to reach your goals.

Those who are unprepared for retirement may need to take more risk in their portfolio to achieve their goals, but they may not have the willingness or ability.

Those who have more than enough money saved may have the ability and willingness to take more risk to grow their wealth, but they may not need to because they have already won the game.

Rarely do the planets align when it comes to figuring out the right investment mix, but the good news is there is no such thing as the perfect portfolio. The perfect portfolio only exists with the benefit of hindsight. And even if the perfect investment strategy did exist, it would be useless if you couldn’t stick with it over the long term. A half-decent investment strategy you can stick with is vastly superior to an extraordinary investment strategy you can’t stick with. Discipline and a long time horizon are the big equalisers when it comes to financial success.

Your ability to withstand losses in the market and stay the course with your plan come hell or high water comes down to some combination of time horizon, risk profile, human capital, temperament and ego. If you don’t understand yourself, your circumstances and your deficiencies when making decisions about money, it’s impossible to truly gauge your tolerance for risk.

Invest Your Way to Financial Freedom by Ben Carlson and Robin Powell will be published by Harriman House on 28 September. But you can pre-order your copy right now!