Make Your Portfolio Keep Up With You

Each of our life stages requires a different set of allocations

By Aaron Levitt, InvestorPlace Contributor

When it comes to treating a portfolio right, many of us have a handle on dividends or understanding the importance of compounding. We even now are starting to vastly understand just how costs/expenses come into play and affect our overall returns. But one of the most important things when it comes to investing is often one of the most ignored.

And that’s rebalancing and adjusting your portfolio according to your life’s stages.

Your portfolio at age 30 shouldn’t look like your portfolio at 65. That’s because as we get older, we have less time for compounding and less time for market errors. And yet, most investors — especially after the last few years of gains — are potentially over-exposing themselves.

Rebalancing and readjusting isn’t sexy, but it’s essential to keep your portfolio running in top form.

Why Re-balance Based on Age?

The idea behind rebalancing is a pretty easy one to understand. The basic gist is that you’re seeking to reduce risk relative to a target allocation. That’s a fancy way of saying what proportion of stocks, bonds and alternatives your portfolio should have.

A portfolio’s asset allocation is the primary determinant of a portfolio’s risk-and-return characteristics. The problem is, stocks, bonds and whatever don’t always move in sync with each other, nor at the same rates. Doing nothing and just holding would dramatically change a portfolio’s allocation by a wide margin as stocks gain, bonds falls or gold goes sideways.

Rebalancing is the process of selling “winners” and buying “losers” to get that portfolio back to its original make-up. In the end, the process actually helps boost returns and limit losses.

What’s missing from the rebalancing conversation is what to do when you arrive at certain life stages. As we said at the opening, a 25-year-old, carefree, just-out-of-college kid has a different set or sensibilities, timeline and portfolio size than someone in their 60’s and on the verge of retirement. Rebalancing for a youngster has a different meaning than for someone older.

And that’s important to realize as you move through life’s stages. Re-balancing isn’t just about moving back to static allocation, but an allocation that changes with age and risk tolerance.

There are no hard-and-fast rules for defining life stages. But most advisors tend to think of three distinct ages brackets, with a few sub-brackets underneath. And while an individual’s risk tolerance determines each bracket’s allocation, the general thought process is roughly the same.

The Accumulation Stages for Your Portfolio

For Early Career Investors (20’s Through 30s): For those just starting their careers, the biggest gains you’ll see from your portfolio will be from own contributions and deposits. And when you don’t have much, you can afford to be a lot riskier. After all, if you lose half of a $5,000 portfolio, it may sting at first, but you’ll likely make it up after several months of work. Additionally, your long lead times provides plenty of compounding time as well as time to recoup from any losses.

As a result, you really can afford to be 100% in stocks when you are starting out. Rebalancing — if at all — comes into play when looking at various asset sub-classes such as mid-cap stocks, international equities or sector funds.

When early accumulators start hitting the upper end of the bracket, stepping off the100% stock bandwagon makes sense and a small allocation to a broad-based bond index fund can help provide ballast.

For Mid- and Late-Career Investors (40s Through 50s): Less time, bigger portfolios and more responsibilities are familiar faces during this stage of life. Kids, mortgages and college funds take a greater toll on the ability to risk it all. Likewise, less time to recover from market swings also plays a major factor in this groups allocation decision. As a result, bonds should begin to play a bigger role in your overall allocation. Again, the idea still is for ballast and not some much income generation and as such a simple index fund can do the trick.

As for equities, the pairing of risk is also warranted. A number of high-growth investments should be slowly phased away with more focus on equity income and blue-chip stocks. The percentage of high-flying small-caps and emerging market stocks should decrease as well. It doesn’t mean you can’t own them, but the percentage should be a lot smaller than when you were 20.

For Pre-Retirees and Retirees (60s Plus): For investors hitting this stage of the game, re-balancing is very critical. You’ll still need stocks for growth, as the normal retirement can last decades, but income should be your number one focus. With retirement in the here and now, there won’t be time to recover from significant losses, so the percentage of stocks should be less than bonds. Likewise, bond exposure through a broad index fund should give way to a variety of various bond asset classes — such corporate bonds, TIPs and other fixed income securities designed to provide yield. Having cash as part of your allocation strategy also begins to make a ton of sense at this point.

Traditional rebalancing also has a major role in this stage of life. If stocks drift higher, retirees and pre-retirees need to diligent to sell these winners to lock in gains before they become losers.

The Bottom Line

While there are no set rules on what your portfolio should look like, we generally get more conservative as we get older. The ability to benefit from compounding and long timelines allow younger investors to own more stocks and risk assets than those closer to retirement.

Rebalancing along our life stages allows portfolios to slowly ratchet down the risk and lock in any potential gains into safer asset classes and securities.

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