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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