There are a few universal truths in investing. It’s always good to buy low and sell high, for example, and there’s no such thing as guaranteed returns. A whole lot else, however, is subjective depending on how old you are, what your goals are and how long you have until retirement.
To find out how to plan a healthy and wealthy investing lifecycle, GOBankingRates talked to experts from a variety of backgrounds to learn how to transition to the next investing chapter with each new phase of life.
Traditionally, investment advisors recommend adjusting your asset allocation as you age to make sure your risk/return profile is in line with your time horizon. Young people who can tolerate more risk are advised to load up on equities such as stocks and then shift their portfolios toward fixed-income securities such as bonds to guard their principal as they age.
One expert outlines a nifty formula for charting that ever-changing asset-allocation ratio over the years and decades.
“A great starting point for proper asset allocation is to take the number 110 minus your age,” said Dawn Dahlby CFP, founding partner of Releve Financial. “For example, a 20-year-old would take 110-20=90. This means a 20-year-old would have 90% exposure to the equity markets and 10% allocated to the fixed-income markets.
“You can see as you age, the equity exposure reduces. A 60-year-old would have 50% allocated to equities and 50% exposed to fixed income vs. the 20-year-old at 90% equity exposure,” Dahlby explained. “As one ages, the time horizon is shorter, which means the exposure to equities is less. Equities are riskier investments that take a longer time horizon for success.”
Keep It Simple When You’re First Starting Out
Investors in their late teens or early 20s are likely to have little knowledge and even less money. If most of what they have should be in stocks, their best bet is a simple and cheap investment vehicle that requires no knowledge, research nor attempts at picking winners or timing trades.
“I would advise them to invest in index funds and ETFs (exchange traded funds),” said Adam Garcia, CEO of The Stock Dork. “They can help individuals track the performance of their respective portfolios. Young investors can easily trade stocks, allowing them to gain promising returns.”
ETFs that track indices like the S&P 500 are perfect for novices because:
- They’re inexpensive and readily available on nearly all free online brokerages
- They’re familiar — you buy and sell them in shares on the open market just like stocks
- They can be purchased in partial shares with brokerages that allow it, meaning anyone can get in the market on any budget
- They provide instant diversification — the purchase of a single share or even a partial share buys you ownership in dozens, hundreds or even thousands of companies
Thanks to the miracle of compound interest and distant proximity to retirement, young people have huge heapings of the greatest investing resource: time. Your 20s and 30s are the years to take big risks in the pursuit of big rewards.
“A person saving for retirement in his or her 20s and 30s can tolerate a lot of risk because retirement is so far away,” said David Frederick, director of client success and advice at First Bank and adjunct professor of economics at Washington University in St. Louis. “Be sure to include a healthy portion of stocks, especially low-cap and foreign. If the young investor can get access to private equity funds, all the better, because he or she can afford to both take the risk and have the funds locked up for a long period of time.”
You can take white-knuckled risks when you’re in your early 20s because you have decades to make up for any losses you incur. It’s reckless to take those same risks, however, after you’ve burned through a few of those decades.
Frederick offers a perfect analogy.
“When you can no longer play basketball with people in their 20s, you probably should not invest like them anymore either,” he said. “It’s time to diversify with an eye to the future. Develop a broadly diversified portfolio that includes some high-upside stock investments but also includes an array of bonds to mitigate the downside. Further, seek out some alternatives like real estate, commodities and syndicated investments. The name of the game is to keep growth going and protect against losses through diversity.”
Shift From Growth to Income When You’re on Deck for Retirement
When retirement is less than a decade away, your investment mindset should shift from building wealth to making it last.
“For people prior to 60, it was all about wealth accumulation,” said Kevin Chancellor, a financial advisor at JAG Financial Services in Melbourne, Florida. “People in their 60s really need to focus on retirement income planning. By this time, people in their 60s should have a combination of tax-deferred, tax-free and taxable investments to pull from when they retire, as well as a healthy cash reserve for down markets and emergencies.
“Every decade prior to their 60s was about getting to retirement as quickly as possible by growing their assets, but now they need to be very strategic and know how much and from what bucket to pull assets so they do not outlive their money.”
Slicing your life up into evenly divided decades is convenient, but imprecise. An alternative perspective is to view investing as a lifecycle with a beginning, middle and end.
“There are three major phases of life that determine your financial priorities,” said Mike Toney, finance director of Car Donation Center. “Accumulation, consolidation and distribution.”
He sums it up this way:
- Accumulation: You’re building capital for later use during your prime earning years.
- Consolidation: In this phase, which starts around 50 or 60, you’re using the capital you built during the accumulation phase to build or buy investments that will generate passive income, such as rental property.
- Distribution: Now you stop working entirely, stop actively investing and rely exclusively on your passive income to cover your living expenses.
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