Why Does Age Matter in Investing?
Investing for retirement is critical at every age, but you should not use the same investment strategies for all ages. Probably the most important single factor in growing your investments is time. Time allows you to let a winner ride for a long time. Time will enable you to rely on the magic of compounding. Compounding happens when your assets make money, which you invest and then generate earnings on those original earnings. In other words, compounding refers to getting more earnings from previous earnings. One of the reasons that tax-deferred retirement accounts IRAs can earn so much money is that the money you don’t pay in taxes allows for more compounded earnings.
Finally, and most importantly, time lets you recover from your mistakes. Remember, if you lose 10 percent of your portfolio, it will take a gain of more than 11 percent to get back to where you started. If you lose 25 percent, you’ll need 33.33 percent. Time helps you make this recovery by allowing you to spread it out.
So, how do all these factors play out when you’re picking your investment strategies by age?
Risk and Age
Investment strategies by age matter because your age, to a considerable extent, defines the level of risk you can afford to assume. In other words, the older you get and the less time you have to recover from a catastrophe, the more you need to limit or manage your risk. Conversely, the younger you are, and the earlier you start saving and investing for retirement, the more risk you can comfortably assume. That’s why, if you want to consider really risky investments like futures or options or even cryptocurrency, you may want to do so as a young person. You can take a small portion of your assets, perhaps even in a different account, and invest those assets in your higher-risk investments. You may make a killing on these highly leveraged, risky investments, or you may take a bath. But you have decades to recover from or take advantage of whatever happens.
How to Choose an Investment Strategy
Picking the categories of investments to add to your portfolio is called asset allocation. Asset allocation is a technical term referring to a system or process for dividing your asset among different asset types, such as stocks, bonds, real estate, and cash. Other asset classes require higher risk tolerance and investment sophistication, including futures, options, and real estate. The allocation that works best for you will change at different times in your life, depending on how long you have to invest and your ability to tolerate risk. Risk tolerance is a term defining the degree of gain and loss ( volatility) in investment returns that you can live with. Some people are comfortable with a very high level of risk; others worry about the risk of losses from treasury bills.
Short-Term Investment Strategy
If you’re 21, with what is probably more than 40 working and saving years before you retire, most people would say that you can afford a portfolio that is approximately 80 percent stock. This reflects the old traditional formula for risk in your account that says subtract your age from 100, and that figure will tell you how much of your assets should be in stocks rather than in income-producing investments like bonds. So, the formula for a 21-year-old is 100-21=79. Remember, even though you are taking a high level of risk, you have decades to recover from any crashes that might happen. If picking your own stocks bothers you, you can look at purchasing age-based mutual funds composed of stocks and other investments that will reflect the relatively high level of risk that a young person should use. You will buy funds that reflect the level of risk appropriate to your age.
Your Portfolio at Mid-Life
As you reach 40, you will likely also start to achieve your higher earnings potential and put more in your retirement account. Of course, your time left is now shorter, so your account should reflect approximately 60 percent stocks and 40 percent income-producing assets like bonds. Although you can continue to use age-based mutual funds that will feature this asset mix, you may want to start thinking about using a professional financial advisor. At this age, you’re not just saving for retirement. You may have children whose education you must plan for and a legacy to start planning. You may also receive a significant inheritance from your parents. A professional can help you avoid expensive mistakes, look at your goals and needs, and help plan your assets for meeting them.
Long-Term Investment Strategy
As you get nearer to retirement, you should work with a professional who can help you smooth out any issues your own investment decisions have left and keep you on the right track for building your retirement assets. A financial planner can also help you plan for spending the assets you have spent your adult life accumulating. The planner will show you ways to draw down those funds that can help you survive retirement by keeping your assets intact longer. For example, some retirement assets, when spent, can make significant adverse changes to your tax liabilities. A professional advisor can help you plan which asset buckets to spend from to avoid these issues and get the most out of your retirement assets. Keeping your taxes low is one great way to preserve your assets.
Investing in Retirement
Just because you have been applying investment strategies by age does not mean that you will stop investing when you retire. Once again, you and, hopefully, your financial planner will examine your portfolio and make sure that even your now quite conservative portfolio (100-65=35) is still producing income to preserve your assets.
Retirement involves many risks, and your relatively fixed income doesn’t reduce those risks. You may suddenly experience high medical expenses for which you haven’t planned. Or, you may lose a spouse to death or divorce, which reduces your income and assets and requires reconsidering things like whether your home is now too big. One of the essential investment strategies by age is planning not to outlive your money.
Do You Need A Financial Planner?
Applying investment strategies by age helps you make the financial decisions you need when you need to make them. Consider starting to work with a financial planner today to help you on your way. A financial planner will understand the subtle interplay of your investment goals and strategies with your risk tolerance and your age. The advisor will be able to fine tune your portfolio beyond just your age, while planning for all of your on-going financial needs.