I am an 83-year-old widow in excellent health and have a problem with my portfolio, which is handled by a financial adviser I have known for many years. In my non-registered account, my portfolio consists of cash and short-term securities (16 per cent), fixed income (39 per cent) and common equity (45 per cent).
My registered retirement income fund consists of cash and short-term securities (14 per cent), fixed-income (30 per cent) and common equity (56 per cent). All the articles say the percentage of fixed income should match the age, but my financial adviser says this is an old wives' tale, and I would go broke before I died if I had my portfolio in that balance.
Would you care to comment? I would really appreciate your opinion. Thank you. - T.D.
The popular "age rule of thumb" rests on the notion that a portfolio should get more conservative as a person gets older. For example, a 30-year-old with several decades of earning and investing ahead should allocate about 30 per cent of his or her portfolio to fixed-income, and the remaining 70 per cent to equities which have higher risk, but potentially higher returns.
An 80-year-old retiree, on the other hand, typically can't afford to take as much risk and should allocate 80 per cent of his or her portfolio to investment-grade bonds or guaranteed investment certificates, and just 20 per cent to stocks.
The age rule isn't carved in stone, however. Because people are retiring earlier and living longer, thanks to better health care and nutrition, their money must last longer. That's why many investing professionals consider the rule to be too conservative.
"While setting and maintaining a suitable asset allocation remains one of the great discussion points of the financial services industry, I think [T.D.'s] adviser is more right than wrong," said John DeGoey, certified financial planner and associate portfolio manager with Burgeonvest Bick Securities in Toronto.
"A couple of generations ago, when the age rule of thumb originated, Canadians generally retired at 65 and died by age 73. Today, people are retiring at about 62 and living to be about 82," he said. In other words, the average retirement is nearly three times longer than it used to be, and this "absolutely, positively demands more equity for all but the wealthiest investors."
Age isn't the only factor to consider when setting an asset allocation. Investors must also take into account their risk tolerance, health, ability to withstand a financial loss, desire to leave a legacy to their heirs or charity and the low returns available on fixed-income investments, he said.
Modifications
With his own clients, Mr. DeGoey uses a modification of the age rule when setting a fixed-income allocation. He recommends multiplying the person's age by one one-hundredth of their age, and capping the fixed-income exposure at 50 per cent. For example, a 40-year-old would have 40 times 0.4, or 16 per cent, in fixed income. A 70-year-old would have 70 times 0.7, or 49 per cent. Anyone older than that should have roughly a 50-50 mix of bonds/stocks.
William Bernstein, author of The Investor's Manifesto: Preparing for Prosperity, Armageddon and Everything in Between, agrees that the age rule is just a starting point in the asset-allocation process. Depending on the person's risk tolerance, the fixed-income weighting could be adjusted up or down by as much as 20 percentage points.
A 70-year-old with a very low risk tolerance, for example, could have as much as 90 per cent in fixed income (70 plus 20). If the person has a very high risk tolerance, the fixed-income weighting could be as low as 50 per cent (70 minus 20).
Retirement
The amount the investor must withdraw from his or her portfolio to fund retirement is another factor to consider.
"An extremely wealthy 80-year-old who lives off of less than 1 per cent of her portfolio might reasonably invest much more aggressively than most folks her age, since it is very unlikely she will run out of money no matter how high her equity exposure is," he writes in The Investor's Manifesto. "In reality, her portfolio belongs more to her heirs and philanthropic endeavours than to herself."
On the other hand, a 70-year-old investor who is depleting her portfolio at a rate of 7 per cent annually should consider spending a chunk of her nest egg on an annuity that provides a guaranteed monthly payment for life.
When setting an asset allocation target, Mr. Bernstein says investors also need to determine what he calls their "equipoise point."
When the stock market is rising, investors will derive pleasure from watching the equity portion of their portfolio rise, but will also feel regret at not having more money in the market. "Your equipoise point is that allocation at which this pleasure and regret exactly counterbalance each other," he writes. "Similarly, during substantial market declines, the equipoise point is that allocation where the pain of loss in stocks exactly counterbalances the warm fuzzy feeling provided by your bonds and the capacity they provide to buy more stocks at low prices."
Clearly, there is more to the asset allocation process than plugging your age into a simple formula. Now that you know what factors to consider, you and your adviser can sit down and discuss whether the allocation chosen is right for you.
John Heinzl