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Myth Of The Month: Age-Based Allocation

Myth of the Month: Age-Based Allocation

4 min read

Have you ever heard the rule of thumb: “Your allocation in bonds should equal your age” or, “Your equities allocation should equal 100 minus your age”? Those are often-used statements, but the truth is that we think there’s a better way to come up with appropriate investment allocations for our clients.

When working with clients, we ask them to take a look at their current growth-fixed income mix and ask themselves the following three questions:

1. Does this allocation have the potential to allow me to reach my short-term and long-term goals? (Step One: Thoughtful Allocation)

2. Am I comfortable with the volatility of this portfolio and can I stick to it long-term? (Step Two: Risk Tolerance)

3. Is passing down assets to future generations a high priority for me? (Step Three: Wealth Transfer)

Thoughtful Allocation

Let’s talk about each of these goals in turn, starting with “Thoughtful Allocation.” One of the tools we use to determine if an allocation is in line with your goals is our Financial Independence Analysis. This program accounts for income, expenses, assets, and liabilities, and uses what is called a “Monte Carlo” simulation to project return sequences based on the particular portfolio allocation. This simulation illustrates whether or not you are in the “confidence zone”, that is, you have a 75-90% probability that your assets will last until your projected lifetime based upon the elements listed above.

In many cases, the old rule of thumb, “100 minus your age” (for example, 40% growth if you are 60 years old), may not be the appropriate growth allocation for you. Depending on your goals, assets, and income, that allocation could land you below the desired 75%-90% confidence zone, which means you could have a significant risk of running out of money before you run out of life. Our approach, on the other hand, allows a client’s individual circumstances, rather than a trite phrase, to help drive the portfolio allocation decision. Let’s look at two examples to explore this further.

Suppose two individuals, Allison and Brad, both age 40, have a growth allocation of 60% in their respective portfolios with the same risk and return profiles. However, variables such as their assets, income, spending, and goals are all different. As illustrated below, upon running the Monte Carlo simulation, Allison has a probability of success of 90% and Brad has a probability of success of 45%. Allison is well within the desired confidence zone of 75%-90%, but Brad falls below.

Asset-Allocation-blog

If Brad is invested in a growth allocation that is suitable for his risk profile, but still falls below the confidence zone (as pictured above), he would need to address the variables in his plan to come up with a strategy that has a higher potential of being successful. On the other hand, Allison has more flexibility. She can likely be invested slightly more conservatively and still meet the same goals during her lifetime, or, she could remain invested at 60% growth or higher in an attempt to maximize how much is ultimately left to her heirs.

Risk Tolerance 

Our first step, just described, provides a window of growth allocations that are in line with successful plans. If you are comfortable with the percentage of growth in your portfolio (along with the accompanying potential risk) we can move on to Step Three, “Wealth Transfer”. If not, you may have to scale back your financial goals to accommodate a more conservative portfolio.

Determining risk tolerance (Step Two) can be a very difficult process and we are not sold on the idea that a typical risk-tolerance survey can easily capture it for our clients. As advisors, we need to regularly take the temperature of our clients and make sure they are invested appropriately and have the fortitude to weather positive and negative times in the market. If a client is invested too aggressively for their personal risk profile, they are likely to jump out of the market at the wrong time and possibly harm their financial plan irreparably.

Wealth Transfer 

If you are comfortable with the window of successful allocations provided in Step One and the portfolio fits your risk profile as described in Step Two, we move towards determining a specific growth percentage. A big factor for many investors is the incentive to pass on assets to future generations. If that’s the case, we take these goals of wealth transfer into account when investing your portfolio, still being sensitive to the goals we need to accomplish during your lifetime.

If you tell us, “I want my very last check in life to bounce,” you may have the flexibility to lean toward the conservative side of investing based upon the “confidence” zone we outlined for your in step one, and still reach your financial goals. However, if you have financial desires that stretch beyond your lifetime, you may be willing to take on additional market volatility in order to potentially leave more assets for future generations.

As you can see, we believe that simplistic rules of thumb—like those often cited for an age-based asset allocation strategy—aren’t usually the most effective investment planning tools for real people. At RegentAtlantic, we prefer to spend time assessing our clients’ short- and long-term goals, risk tolerance, and wishes for handling their wealth at the end of their lives. Every client’s situation is unique, so they deserve much more than a turnkey financial strategy. That’s our  favorite rule of thumb!

 

Important Disclosure Information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable. Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request. This article is not a substitute for personalized advice from RegentAtlantic. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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