Stop Investing According to Your Birthday

It’s a common misconception that the older you are, the more conservative you need to be with your money. When you’re young and in the early to mid stage of your career, goes the thinking, your money should be invested entirely in the stock market. And as you get older, your portfolio should become less risky by shifting toward bonds.   

But age isn’t really the relevant factor when it comes to asset allocation. The better question is when you need your money.   

Now, to be fair, it is appropriate for many people to reduce their portfolio volatility with increasing age. Many Americans don’t have a pension or alternative extra source of income and require more than their monthly Social Security check to pay the bills.  

In these cases, a portfolio that contains a generous portion of bonds is almost always a wise choice. By transitioning a portion of your portfolio out of the stock market and into bonds (most likely with a bond ladder of varying maturities), you can protect against a dip in the stock market that erodes your portfolio at the very time you need that money to cover living expenses. Moving into bonds can also produce a reliable income stream.  

It’s typical for portfolios to go from, say, 100% investment in equities for someone in their 30s to a 60-40 stocks-bonds split by age 60s. This scenario has become so common that it’s no wonder we assume that age dictates investment strategy. 

But consider this alternative and unexceptional scenario: You are approaching retirement or already retired and your pension, Social Security, trust distributions, and required minimum distributions from retirement accounts more than cover your annual expenses. In this case, the allocation of your taxable accounts and Roth IRAs should almost certainly not be invested the same way as someone the same age whose retirement plan relies on spending down their brokerage and retirement accounts to cover living expenses.  

The second person should shift into bonds to protect the owner’s living in retirement. In contrast, accounts that won’t be withdrawn in the coming decade or two—much like a typical 35-year-old’s retirement account—can be left in stocks to earn their higher expected long-term returns. Because the money won’t be needed for some time, it can remain invested through market downturns, with a greater chance of recovery over time. For accounts without ongoing withdrawal needs, remaining invested in equities can usually capture their long-term growth potential. 

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If you are older and a portion of your portfolio is not earmarked for retirement spending, you may also want to consider investing a portion of your net worth with the goal of stewarding it for the next generation. If you will not need to fund your expenses during your lifetime by selling certain assets—be they stocks, real estate, or other long-term assets—there is often no reason to sell them during your lifetime just to invest in bonds at a lower rate of return.   

If a brokerage account’s portfolio is instead left invested in the stock market, your heirs stand to inherit a larger amount than they would if you invested your portfolio more conservatively. Remember also that inherited stock from taxable accounts receive a stepped-up basis, meaning that your heirs will not owe capitals gains taxes on any of appreciation accrued during your lifetime.  

Approaching financial planning with a multi-generational mindset has important implications when it comes to managing a portfolio. Instead of minimizing taxes owed or maximizing dividends during a given year, your advisor can help minimize overall taxes owed by a family and maximize inherited wealth to your children or favorite charities over your lifetime and theirs.   

A wealth-stewarding mindset can likewise be helpful when considering Roth conversions. Roth conversions take money from a pre-tax retirement account, such as an IRA, 401(k) or 403(b), and invest it in a Roth IRA account. Roth conversions trigger income tax in the year you convert the funds. After the conversion, however, the funds can grow tax-free for the rest of your life and even after death, and can be withdrawn tax-free by either you or your beneficiaries. (Beneficiaries of an inherited Roth IRA must comply with varying distribution schedules, but these distributions are always tax-free).  

After reviewing your full financial picture, if you determine that you will not need to access some or all of the funds in a retirement account during your retirement, you may have the opportunity not only to maximize growth for the next generation (by remaining invested in stocks) but also to save your future heirs significant money in taxes. (To take full advantage of this technique, you’ll want to have available funds from another, non-tax-advantaged account to pay the tax bill from the Roth conversion.)  Again, portfolio investing should consider not just your age, but when or even if different buckets of money will most likely be needed. 

The age-risk misconception is not just relevant to those nearing retirement. It can equally be felt by someone in early or mid adulthood. Very often, we speak to clients who assume that because they are young, their money should necessarily be invested 100% in stocks. But take, for example, a working 35-year-old who is eagerly saving money for a down payment on a house in the next couple of years. If her savings is invested exclusively in stocks and the market hits a sudden bump in the road, the value of her portfolio could quite possibly fall below the level at which she could make her desired down payment.  

A prudent advisor will take your life plans and not just your age into account when designing your portfolio. In the case of the thirty-something that is looking for a home, that prudent advisor would likely shift a portion of her portfolio out of stocks and into bonds. That way, a market downturn is less likely to strip her of a downpayment when the right house comes along. Again, age is not what’s important here; it’s the client’s time horizon for tapping into her investments that matters. 

As with all investing decisions, the most effective allocations come after fully examining your financial picture with an advisor. Wise planning takes into account more than annual income and investments, and considers factors like long-term goals, needs, expectations, and more.