|Starting Age||Life Expectancy||Time Horizon|
They say that the first person to live until 150 has already been born. So how realistic is a 30+ year investment time horizon?
This question has become increasingly important especially considering the low interest rate environment with which we are currently confronted. Establishing a proper investment allocation has never been more pertinent in maintaining a consistent standard of living. Before answering a simple questionnaire and locking yourself into a balanced fund with a pre-set bond/equity allocation mix, there are several factors to consider.
What is your progressive time horizon – when do you actually need all the money? Your time horizon may be longer than you think. For example, after evaluating your income needs through a properly crafted financial plan you come to the following conclusions:
- You will need a maximum of 25% of your portfolio in the next 10 years – this portion will correspond to a Conservative type portfolio (assume 70% Defensive, 30% Growth) which would reduce volatility in order to permit the withdrawal of money without having to worry about day-to-day fluctuations
- The following 10 years will require an additional 25% income from your portfolio; this portfolio has a much longer time frame and a Growth portfolio would be more suitable (assume 30% Defensive, 70% Growth)
- The ensuing 10 years you may need the balance of the funds or perhaps they may used by the next generation. These funds would benefit from an All Growth (Equity) portfolio (assume 100% Growth)
It’s understandable that if you are within retirement range or currently retired, an equity correction will scare you. However if you recognize that only a portion of your nest egg will be used in the following 5-10 years and the rest may have a much longer time horizon, you will be less likely to make quick reaction decisions to move in and out of positions at inopportune times or change your allocations.
Much research has been done that shows the average individual investor sells equities at their lowest point and buys them at their highest.
In 2007 (at the market’s highest point) investors were buying stocks. In 2008 (at the market’s lowest point) investors were selling off their stocks. These phenomena are a response to short-term volatility and the fear of losing capital. Ironically it’s this behaviour that actually destroys long-term capital.
Why does this happen? Investors generally have a good idea of what their asset allocation is, however do not always recognize their ‘progressive’ time horizon and do not have the capacity to wait out a bear market. For example, if you invested right before the financial crisis and stuck to your guns, your portfolio would be higher. Making changes would have impacted that recovery. In fact over the last 5 years, if you had missed just 20 of the best days, your portfolio would show a loss as opposed to a gain. It’s an advisor’s role to help clients understand this concept to prevent the deterioration of long term accumulation in a client’s portfolio.
In other words, the classical premises upon which we base our asset allocation models, are not valid. In addition they are not being properly applied or implemented. Asset allocations are being changed based on equity fluctuations and not life cycle fluctuations. By looking at fund flows in the last 10 years, the evidence shows there have been huge inflows into bonds and balanced funds; these inflows are disproportionate to income needs over the next decade. Portfolios are structured as though the client will deplete their investments much faster than they actually do.
The following steps can help determine an action plan and establish a proper allocation which takes into account your progressive time horizon:
Step 1 – Set your goals: Consider your short-term, mid-term and long-term goals
Step 2 – Identify the most common risks: Longevity, Inflation, Withdrawal risk
Step 3 – Evaluate your progressive time horizon and income needs
Step 4 – Align your portfolio with the information above
Preparing a financial plan is essential to evaluate time horizon and long term needs and should be the foundation of investing in a diversified portfolio. I’ll be happy to review any of these items with you at our next meeting.