Our investment portfolios can, and should, change a lot over time. When we are younger we can afford to take more risk. After all, we have decades in which to save and time to recover from any stock market crashes. As we get older and start approaching our retirement, we then start to 'de-risk' as we can't take as many chances with our money. But what does de-risking actually mean and how should we go about it?
Then vs now
There is an old rule of thumb that suggests investors should match their bond allocation to their age. So, for example, if you are 20 years of age you should hold 20% in bonds and the rest in equities. As you get older you should switch your investments from bonds to equities and, for example, by the time you are 60, you should hold 60% in bonds and 40% in equities.
While the logic makes sense I'm of the opinion that it is very outdated. Longevity is changing the way we should think about our retirement savings. A few decades ago, it was not unusual for someone to die within a few years of retirement. Today we can expect to live for two decades or more. So we need our money to last longer. This means our portfolio needs to continue to grow, whilst we take a regular income. For that to happen, we need to retain a higher level of riskier assets in the make-up of our portfolios.
Even more outdated, in my opinion, is that other old rule of thumb that, once we reach retirement age, we should invest only in government bonds and cash. Yes, we need to think more about where we will get our income in retirement, but are government bonds and cash the only way of achieving this and are we playing it 'too safe'?
Nothing is risk-free
For starters, neither government bonds nor cash are yielding much at the moment. There is the possibility that interest rates, having been at a paltry 0.5% for more than seven years already, will be cut further in the coming months. Cash savings rates are having a tough time keeping pace with inflation, which means our purchasing power could fall. Some overseas government bonds now have negative yields and there is the danger that gilts (UK government bonds) will follow suit.
If and when the interest rate cycle does turn, and interest rates rise, the yield on bonds will increase, but their price will fall – so we could lose some of our original capital investment. So bonds aren't perhaps as low risk as people think they are. A 70 year old with 70% in bonds could see their pot of money fall quite considerably, with no way of making up the difference.
I would never encourage anyone to take on more risk than they can tolerate. After all, retirement is supposed to be the time when we are relaxing and enjoying ourselves, not lying awake in bed at night worrying about what the FTSE 100 is doing. But if we don't take on a bit of risk, the worry could well be that our finances are running out faster than we thought they would.
So my recommendation is that, we shouldn't limit ourselves to old rules of thumb and traditional 'retirement' assets. We can continue to diversify our portfolios in meaningful ways no matter what our age.