June 13, 2007, 3:30 am

Financial Cliché II: The proportion of stocks in your portfolio should equal 100 minus your age

by: The Financial Blogger    Category: Financial Cliché
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This is a second post of my Financial Cliché Series. I think it is important as to often we hear stuff about finance that just doesn’t make sense. Many people rely on their financial institution or on a financial consultant to manage their finance. I think it is a good thing as most individuals don’t have financial back ground. You trust you doctor for your health, your mechanic for your car (maybe you shouldn’t!) and your financial consultant for your finance. However, some people trust their brother-in-law or your neighbour for financial advices. Most people think that you should calculate the proportion of stocks in your investment portfolio solely based on your age.

The rule is pretty easy. Take the number 100, deduct your age and you get the proportion of stock in your portfolio. According to my opinion, this is completely wrong. In fact, your investment portfolio should be built according to your risk tolerance, your goal and your investment horizon.

You might not have the same plan as your neighbor that is the same age. What if you are comfortable with big fluctuation? You would like to have a higher expecting return even if it means more risk involved as you like rock’n roll investments. You would be pretty bored by 30% of your portfolio being invested in fixed income at 5% at the age of 30!

If you are planning to buy a house in the next three years or if you are planning to go on an all over the world trip, you might not want to take too much risk even if you are 26. Most of your investment should be in fixed income, low risk mutual funds. As you plan to withdraw your money over a short term period, you can’t avoid any major drop on the market. If it ever happens, you might not be able to buy your house anymore! I did in the past, and I had to borrow money from my parents to cover my cash down. I was playing with penny stocks and the results were not as good as expected. Therefore, your investment goal is really important before setting your investment strategy.

Investment horizon is another thing. Even if you are 55 and retired, you should not put 45% of your investment in fixed income. You would end-up paying high taxes (interest income is taxed on your marginal tax rate) and not profit from growth. Life expectancy is increasing and you might live up to 85 without any problems. That’s 30 years of growth that would be totally lost. Can you really afford that?

In the end, the main thing to remember is to not let anybody else establish your investment strategy. You should question your financial consultant and he should be there to guide you and not to complete all the investment forms before you meet. And please, stop listening to your neighbor/brother-in-law/that-guy-you-know at-work¦ unless they are millionaires!

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Comments

I find it ironic that you are suggesting that investors should take appropriate risks (correctly IMO) just after saying the increased risk in leveraged equity investing is nothing to worry about.

Nothing like learning from experience eh?? lol.

This is a good post. Another cliche or ‘rule of thumb’ which I don’t like and you can write about is “contribute to your rrsp and put the refund in the mortgage”. While this isn’t bad advice for most people it certainly doesn’t fit everyone’s situation. Some people should put all their money into the rrsp (incl refund), some should just pay off debt, some should invest outside mortgage etc or more likely some combination – but each person has to look at their own situation.

Mike

by: The Financial Blogger | June 13th, 2007 (11:17 am)

CC : What I am saying is that there is a risk in investing money on the market, especially if you are investing everything in emergent market for example (remind you of anyone?). However, I think that people overestimate the added risk by leveraging as over the long run, history has proven positive return over time on a well balanced portfolio. As I already stated, there is a risk of dying in a car accident but we are all still driving work everyday.

FP : At least I learnt something 😉
I think that most “rule of thumb” should not apply in personal finance. As the term says, it is personal :;-)

Cheers,
FB.

I’m not sure if you can compare the risks involved with doing a essential activity like driving to work with the risks in leveraged investments which is a totally optional activity.

FB: I am not sure what you are hinting at when you say someone invested in emerging markets. I’ve never suggested anyone should be overexposed to emerging market equities and I personally don’t have any exposure.

The logic of leveraging is not in doubt. The most important question is are investors able to handle the extra risk compared to investing your own money. Why is that people who sing the praises of leveraging never point out the downside? In that context, I find it interesting that you say investors should take appropriate risks.

BTW, what’s your point with the analogy between driving a car and investing? If you are saying both are risky and everyone drives a car, so everyone should take the risks of leverage, it is a silly argument. Putting one bullet in a revolver, pointing it to the head and pulling the trigger is a risky activity too. So, why don’t all leveraged investors try that once in a while? After all, it’s all taking the same risks, right?

by: The Financial Blogger | June 13th, 2007 (2:23 pm)

CC: I must admit I had a good laugh thinking about your revolver example :smile:. Most people do almost the same thing with their investment, following the market like sheeps.

I was refering to your most recent post about this guy that has 22% in emergent market. I don’t know your whole personal investment strategy yet (didn’t go through all your blog either) so nothing personal here.

I’ve seen many financial plans and they all show what can happen if things turn bad. Sure you can lose all your money and still owe a considerable amount to the bank.

This last sentence leads to my analogy. My point is, the worst of life can happen at any time, anywhere. But considering the real risk of dying in a car accident, or leveraging over 10,15 years, we find out that they both are minimal.

I do think that everybody that has a high marginal tax rate (starting around 50K) should leverage. Some with smaller amount like 10K, some others with 250K depending on your whole financial situation. They should not leverage because it is a risky activity, but because it will surely create wealth overtime.

Cheers,
FB.

I wandered onto this blog recently. Keep up the good work. I would suggest that you study the tax implications of your post though- if you are 55 and retired, I suspect your income would be quite low and any interest income from fixed income instruments is not going to push you into a higher tax bracket. However, if you are 55 and working (on the assumption that you have a lot of seniority), you may be in a high tax bracket and fixed income should be in tax sheltered accounts.

I am like CC- I do not believe leverage is a catch all solution for all investors. The average investor, unfortunately, preforms well below the TSX/S&P indexes and adocvating leveraging for “everyone” making over $50K is a dangerous strategy for those who do not have a track record of investing wisely.

To each their own, one supposes. Keep up the good work.

by: The Financial Blogger | June 15th, 2007 (1:22 am)

Hi TMW,
I will definitely look into more tax implication and probably more post on leverage so I can convince you and CC (that will be quite a challenge!) that leveraging should be part of any financial plan (at a different degree).
Cheers,
FB.

Thanks FB. You don’t have to convince me of anything! As long as you are comfortable with the strategy you are pursuing and its profitable and ethical than all the power to you.

After all, isn’t “to each their own” a French saying! Have a good weekend.