Asset Allocation: Considering Age Factor for an Investor
If you’re seeking guidance on investing in your 30s or want to know how your investment portfolio should look by the time you’re 50, you’re likely interested in an age-based asset allocation approach.
In this blog, we will delve into the concept of asset allocation, its significance, and the specifics of age-based asset allocation.
What is asset allocation?
Asset allocation pertains to dividing your portfolio into various asset classes. The objective is to construct a portfolio comprising diverse asset classes, enabling the portfolio to align with your preferred risk and return preferences.
Asset classes refer to products such as equities, fixed-income securities, commodities, real estate, etc. Asset allocation can be based on various factors such as age, risk appetite (tolerance and capacity), or investment approach.
Why is Asset Allocation Important?
- It Reduces risk
Diversifying your portfolio through asset allocation is a time-tested effective strategy. You can spread your risk by allocating your funds across different asset classes. Additionally, within each asset class, you may opt for further diversification by investing in multiple assets of the same kind. This extensive diversification minimizes your exposure to any individual investment or asset class.
- It Optimizes returns
You can construct a portfolio that delivers returns aligned with your financial objectives through asset allocation. The selection of assets to invest in depends on the amount of returns you require and how frequently you anticipate receiving them.
- It Manages your liquidity needs
Assigning a portion of your portfolio to liquid assets assures that you can withdraw money in the event of a financial need.
- It makes tax planning simpler
Tax policies can vary depending on the asset classes you invest in. By maintaining a record of the asset classes you invest in, you can accurately compute the taxes on your investments in a well-organized manner.
Asset allocation by age
As individuals age, they have fewer earning years left and added responsibilities. Consequently, investors may become less inclined towards high-risk-high-return investments as time progresses. This principle forms the foundation of age-based asset allocation.
If you opt for age-based asset allocation, your portfolio will gradually shift funds from riskier to more secure investments. When you are young and can recover from losses, your portfolio may have more allocation to assets with growth potential. In contrast, a portfolio with a higher allocation of safe assets would be more appropriate at a later age.
Rule of thumb for age-based asset allocation
An age-based asset allocation rule of thumb suggests that the percentage of your portfolio which is invested in equities should be 100 minus your age. Therefore, the percentage of the portfolio assigned to safer investments would equal your age.
Equity allocation percentage = 100 – Your Age
Safer asset allocation percentage = Your Age
| Age | Equity allocation | Allocation to fixed-income assets |
| 23 | 77 | 23 |
| 24 | 76 | 24 |
| 25 | 75 | 25 |
| 26 | 74 | 26 |
| … | … | … |
| 60 | 40 | 60 |
| … | … | … |
| 80 | 20 | 80 |
As per age-based asset allocation, individuals in their 20s would have a growth-focused portfolio, while a 50-year-old would have an equally-weighted portfolio. Those close to 80 would have a retirement-focused portfolio with a conservative allocation.
However, it’s important to note that the age-based asset allocation strategy outlined above is based on a limited set of factors. Adjustments may be necessary depending on your risk appetite, income, and future objectives. Various factors can be employed to modify these strategies to suit your unique requirements.
There are several aspects to consider when it comes to asset allocation:
Firstly, fixed-income assets are not limited to fixed deposits alone. You could also invest in government securities through a Retail Direct Gilt Account that offers interest payments customized to your needs.
Secondly, you could employ various equity investment strategies such as growth investing, value investing, Systematic Investment Plans (SIPs), and diversify your portfolio using Exchange-Traded Funds (ETFs).
Thirdly, while asset allocation strategies generally recommend one rebalancing per year, you could also consider rebalancing whenever the allocation drifts excessively from your desired target.
Final Thoughts
Age-based asset allocation strategies are based on the idea that our risk appetite declines as we age. While younger individuals may be comfortable taking risks, those nearing retirement may prefer a more conservative approach. However, each person has unique responsibilities, goals, risk tolerance, income, and investing styles.
Thus, age-based asset allocation strategies must be customized to suit an individual’s specific requirements. While they offer a good starting point, it’s essential not to limit yourself to them and be open to modifying them as necessary.
FAQs
Age-based asset allocation proposes that younger individuals have more time to recover from losses and can, therefore, have a higher concentration of equity in their portfolio. In contrast, as people get older and have more responsibilities, they may have less time to recover from losses. Therefore, the strategy suggests shifting funds to fixed-income assets as they age to reduce risk.
While age-based investing theories propose that 25-year-olds can take risks and experiment more due to having more time to recover, it’s important to consider multiple factors before making investment decisions. These factors may include career growth prospects, family plans, living expenses, and other personal financial goals. Having a comprehensive approach to investing can help ensure that your investment strategy aligns with your unique financial situation.
No. Although it is advisable to start investing as early as possible, even if you start at 30, it is not considered too late.
“Rule of 100” suggests subtracting your age from 100 to determine the percentage of your portfolio that should be allocated to equity. The remaining percentage allocation should be in safer assets.
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