Category Archive 'Asset Allocation'

Asset Allocation for Retirement

Asset Allocation

Last week, I discussed the importance of making an asset allocation by age. In this post, I was explaining my “ideal” asset allocation according to your age. From the age of 51 until 65, I suggested investing in a balanced portfolio. This includes having 50% of your portfolio “at risk”. Why would you invest so much in equities when you are about to retire? There are some reasons why asset allocation for retirement should be relatively aggressive:

#1 You didn’t save enough when you were younger

The very first reason why your asset allocation for retirement should contain about 50% in stocks or index ETFs is because you may not have saved enough throughout your life. Therefore, low investment returns (such as 3-4%) won’t be enough to create a comfy nest egg. You will need to reach for a 5 to 6% investment return in order to retire early and happy! If you secure your asset allocation in bonds, you won’t be able to make it. This is why around 50% of your investments should be related to stocks in the decade before retiring.

#2 You will live longer than you think

There are 2 major mistakes people commit when they do their retirement planning:

a)      They overestimate their investment return

b)      They underestimate their life expectancy

While overestimating the investment returns (thinking you will be making 7-8% over the next 20 years) is an obvious mistake, many think they need money until they are 80 or 85… Well chances are that you will live until 90, 95…maybe even 100!

If you live until the age of 90, you need a much bigger investment portfolio than if you didn’t think you will see the sun after the age of 80. Here again, you will need to count on a higher investment yield to support your lifestyle. Modifying your asset allocation for retirement is about one of the only things you can do to make sure you have enough money.

#3 You won’t withdraw all your money in the first 5 years

Many people think that once they retire, they must invest in very secure investment vehicles. They are about to withdraw money from their investments and they fear any fluctuations. This is usually why they make the mistake of playing around with the asset allocation upon retirement. This is a very bad move!

When you look at it bluntly; you will be withdrawing money from your investments during the next 20 to 30 years. Therefore, there is no rush to change your asset allocation for a more conservative portfolio. A good asset allocation for retirement will be one that:

a)      Will be flexible (so you can withdraw money on a steady basis)

b)      Will protect your capital against inflation (so you don’t lose your buying power over time)

c)       Will ensure you have enough money throughout your retirement! (so you don’t have to go back to work!)

Asset Allocation For Retirement – Sharing my model

I will go a little bit further with determining your asset allocation for your retirement by providing a model. Personally, I would start by creating a 45% fixed income, 55% equity portfolio with more aggressive investments in the fixed income portion if you are between 50 and 65;

25% of your investments in municipal bonds or mortgage funds

This will give you a solid base with little fluctuations. The fact that you are mixing mortgage funds with bonds will protect you from the risk of interest rate increases (as mortgage funds have shorter durations than bonds).

20% in a dividend ETF or stocks along with preferred shares or high yield bonds

This part of your asset allocation will still count as fixed income but will definitely run into some variations. If you are not too sure about dividend investing, I suggest you take a look at What is a Dividend, a reference for beginner dividend investors.
20% in US index ETFs

The US market is probably the most diversified and effective stock markets in the world. You can find very good companies that operate all over the world. While it hasn’t given much to its holders during the past 10 years (mostly because of the 2008 crisis), I think that the next 10 years will be different!

15% in Canadian index ETFs

Most investors are advised to invest a part of your account in commodities. While I don’t like commodities and would rather invest in companies, I am picking the Canadian market in my retirement asset allocation. Why? Because a great part of the Canadian economy is driven by different resources such as oil, gas, gold and paper. Buying the Canadian index is like buying commodities without taking all the speculative risk on your shoulders.

10% in International index ETFs

Since the beginning of this retirement asset allocation model, we have discussed nothing but North American investments. I think that having a part invested in the international market wouldn’t hurt either!

10% in Emerging Market ETFs

Finally, emerging markets should be part of any retirement asset allocation model. Why? Because you will probably live as a retiree for 20, 25 even 30 years. This is why you need some sources of growth over the long term. Emerging markets seem to be the perfect investment vehicle for that!

What do you think of my retirement asset allocation? Do you find it too aggressive? Would you be comfortable with such an asset allocation?

Asset Allocation By Age

Asset Allocation

At my day job (being a financial planner), I take care of the investment of many individuals. While most of them are concerned about their yield or about the latest moves done by the portfolio manager, almost all of them ignore or diminish the importance of asset allocation. I’ve written about etf asset allocation and how building your own asset allocation model is important. In fact, the asset allocation (e.g. diversification) is the most important factor that explains the yield you are getting.

Asset allocation by age

Unfortunately, there are no magic tricks to find the perfect asset allocation. Some say that you are better off with index ETFs while others will preach for a more balanced approach with a mix of secure bonds and equities. The perfect asset allocation is not the one which will make you rich but rather the one that will fit your investor profile. One of the key factors in determining your investing profile is your age. While it’s not the only factor to take into consideration, you can usually manage your asset allocation according to  your age:

Asset Allocation from 18 to 35

While you should not be having much money to invest during this period, this is where you should risk the most. Technically, you should not need the money you invest for retirement for a good 30 years. This is the perfect time horizon for an investor.

I would then think that an asset allocation with 90% to 100% in stocks would be ideal. You can invest through mutual funds or index ETFs as well as trying to build your own stock portfolio. Why should you select such an aggressive asset allocation? Simply because it will be the type of portfolio with the highest expected yield over time. Investing in bonds at such early age will minimize your profit expectancy for nothing. If you are inexperience, I would suggest you leave the temptation of being your own broker and you adopt a “coach potato” approach through ETF investing.

Asset Allocation from 36 to 50

This is usually the time of your life where you get a better job (therefore better salary!) but also where you get most of your expenses. Several people in their 30’s will find the perfect one and fund a family. With the family often comes 2 cars and a house… so a lot of expenses!

You probably don’t have much time to take care of your asset allocation and you might not have much money to invest (then again!). however, it is important to start investing as soon as possible and if you have not started yet while being in your 30’s, you will be running late to fund your retirement portfolio.

Since you might be a little bit concerned about your investment fluctuation since you have several financial obligations, I think that having a small portion of your portfolio into bonds should be a good thing.

Try to aim for an asset allocation including about 75% of equity and 25% of bonds. At your age, you still can afford a lot of risk and you should not be shy to take them. The 25% in your asset allocation will smooth your investment returns during important crisis but won’t slow down too much.

Asset Allocation from 51 to 65

During this period, you will be about to retire and definitely be thinking of your withdrawal strategy. However, it’s not a reason to freak out and secure your asset allocation to the maximum either!

Since you won’t be withdrawing much of your investment during at that age, you can still handle some market fluctuations. Going from a growth to a more balanced asset allocation seem logical. Therefore, a 50%/50% asset allocation approach would allow you to earn some decent investment returns while not suffering too much during market crashes.

At that age, the last thing you want is to see your investments going down by 20% or more!

Asset Allocation from 66 and older

This is for sure, you will be retired during this period of your life. If you have been investing throughout your whole life, you should be sitting on a solid nest egg. There are no reasons why you should risk in the name of higher returns.

A more secure asset allocation showing a 75% to 100% bond/cd’s portfolio is reasonable. You will simply have to manage your withdrawal schedule and avoid to have too much money concentrated into one bond. I would also leave the world of ETF’s to concentrate on CD and bond holdings.

Final thoughts on asset allocation by age

If there was only age to manage when we are talking about asset allocation, things would be pretty easy! However, this is far from being that simple. In fact, age is only a mathematical data that doesn’t take into consideration your risk tolerance. You might be young enough to support a big market drop as you will have time to play with you to gain it back, if you are about to have a heart attack when the market goes down by 5%, you won’t last until your retirement!

On the other side, I personally think that I will maintain a very high level of stocks until I retire. I don’t really mind about market fluctuation and I believe I can earn higher returns by staying invested in the market. I must also admit that I have a good portion of my portfolio which is invested in dividend which are less risky than “regular” stocks.