Stock Investing Myth: Asset Allocation is Based on Your Age

Many financial advisers and planners still hold onto the notion that your investment capital should be split between stocks, bonds and cash based on your age.

One popular formula subtracts your age from 100 to arrive at a percentage mix between stocks and fixed income investments such as bonds or U.S. Treasuries.

For example, based on this formula, if you were 55 years old you should have no more than 45 percent of your capital in the stock market.

While age is a factor to consider in assessing how you should allocate your capital, it is only one of many factors that need to be assessed. Failure to look at other factors could jeopardize your financial future and whether you are able to live your retirement life in comfort or in poverty.

Age allocation alone does not take into consideration the following factors that will have a direct impact on how you invest:

1. Your Physical and Mental Health

With advances in medicine occurring at an alarming rate in the 21st century, the baby boom generation and all future generations can expect to live not only longer but healthier.

With the average life expectancy creeping over 85 years of age for both men and women, the smart investor needs to consider having both the cash flow from investments and the preservation of that investment capital to last at least 25 years into retirement.

Having the majority of your investment capital allocated in fixed-income investments that just barely beat the rate of inflation is a recipe for financial disaster down the road.

2. Your Personality

Some baby boomers are choosing to remain in the work force longer than age 62 or 65 just because they are still highly productive in the workplace. Many have been blessed with good health as a result of a healthy lifestyle and are capable of being worthwhile contributors.

And if you still have your wits about you, you can continue to actively manage your stock investments well into your 70s. Who knows, you may be like me and actually take great pleasure investing in the stock market. It is a fun game to play once you know the rules and have some game-winning strategies in your arsenal.

3. Your Financial Education

If over the years you have become a well-educated investor capable of consistently generating double digit returns in the stock market, why wouldnt you want to continue to do the same well into retirement?

Through financial education you empower yourself to become a better stock investor. When you reach a point in your education that you can make money in any market conditions, it gives you the confidence to continue to be an active player for decades to come.

4. Size of Your Nest Egg

Having amassed a fortune by retirement does take the pressure off of you to generate a certain return on your portfolio or monthly cash flow to pay for your desired lifestyle. Unfortunately, most Americans will not have an adequate amount of money set aside in retirement to fund the majority of their retirement through fixed-income investment vehicles such as bonds, annuities, or U.S. Treasuries. They will still need to look to the stock market to help them generate higher returns over years, even decades, to come.

What really matters in determining the correct asset allocation mix for your portfolio boils down to three key factors, namely:

1. Your investment time horizon, which is influenced by your age to retirement plus the number of years expected in retirement. It is better to plan to have your retirement funds last in the event of a long life expectancy rather than outlasting your funds because you invested in too many fixed-income investments.

Keep in mind that the longer your time horizon, the better the odds are that stocks will significantly outperform bonds or cash as investments. Over 20-year rolling periods from 1927 to 2009, stocks have experienced an average return of 909 percent compared to bonds with only 247 percent.

2. Your expected return on your overall investment portfolio, which affects how much you will have throughout retirement. You must plan for both capital preservation and appreciation of your portfolio, especially if you are faced with being in retirement for 30 or 40 years.

This will mean having a higher percentage of your capital invested in the stock market even during retirement. Doing so allows you to continue to grow your nest egg and/ or reduce the draw down of your capital.

3. Your cash flow needs, to cover your living expenses and future needs well into your 80s. Investing in the stock market provides you with the opportunity to generate the cash flow that you will require to sustain your lifestyle well into the future.

Basing your asset allocation primarily on an age formula can spell disaster for you in the future. Failing to plan for enough growth in your investment portfolio to cover the effects of inflation that will erode your nest egg over several decades could radically change your lifestyle for the worse.

No one cookie cutter formula is going to necessarily fit your particular needs when it comes to your financial future. You are much better off in analyzing your individual situation in the context of the above seven factors to arrive at an appropriate asset allocation mix.

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