The plight of middle-aged investors

May 26, 2009

david-kuo_motley-fool- David Kuo is director at The Motley Fool. The opinions expressed are his own. -

What is the one thing that young investors have but older investors would give their eye teeth?

This isn’t a trick question and nor does it have anything to do with body parts.

The answer is time. Older investors may have more money, more experience and more investing knowledge than younger investors. But the thing that older investors don’t have on their side is time – time to correct mistakes should anything go wrong with your investments.

In particular, time has to be a key consideration if your investment forms a vital part of your retirement portfolio. That is why older investors are regularly urged to rebalance more of their portfolios to less risky investment the closer they approach retirement age. If you are wondering how to rebalance a portfolio, there is a handy rule of thumb that may help. It’s only a rule of thumb so it will have limitations depending on the length of your digit.

It simply states that the proportion of your investment portfolio allocated to cash should be equivalent to your age expressed as a percentage. Put another way, you can afford to take more risk with your investment the younger you are. But as you get older you should start shifting more of your money into cash.

So, 25-year-olds should have no more than 25 percent or a quarter of their portfolios in cash; 33 year-olds should only have a third or 33 percent of their investments in cash, and so on.

By the time you reach middle aged or around 50 years of age, about 50 percent or half of your investment should be in cash. The rest can be in shares, property, corporate bonds or any other type of investment that takes your fancy. The reason for allocating more of your investments away from shares is because cash or near-cash investments such as Governments Gilts are safer.

Shares on the other hand can be volatile. The value of a share can fall (to zero) as well as rise (to great heights) but cash won’t. It will grow at a few percent a year, which is great if you happen to have lots of it and don’t plan to spend any of it.

But there are a couple of things to bear in mind before you rush to sell off your portfolio of shares. The rule of thumb does not take into account longevity or inflation.

These days, more people are living longer. Around 30 years ago, we would consider living to 72 years of age to be a fairly decent innings. Today, the average life expectancy is 78. Additionally, it is not inconceivable that life expectancy could improve further with advances in medical science.

Consequently, we need to ensure that our investments more than keep pace with inflation. Whilst it is generally accepted that cash is seen as safer investment, we have to also appreciate that their returns are lower than that of shares. That may seem a preposterous thing to say now with the stock market looking limper than a two-week-old iceberg lettuce leaf. But even middle-aged investors have time on their side. As they say, it’s time in the market, not timing the market that’s important.

So, can a return of 2 percent on cash be adequate for my retirement, which could be for as long as thirty years after I retire? I very much doubt it. So, I’m going to take my chances with a portfolio of lower-risk shares instead.

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