Our guide on Lifecycle investing covers the following topics:
- What is lifecycle investing?
- What are the different lifecycle stages?
- How to choose the your lifecycle stages
- Lifecycle investing conclusion
What is lifecycle investing?
Lifecycle investing is a strategy that helps you balance the assets in your portfolio to manage your risk and achieve your investment goals.
Traditional portfolios contain a mix of assets, usually a split between stocks and bonds (commonly referred to as equities and fixed income).
Stocks are riskier than bonds. Therefore, investors adjust the percentage of stocks they hold in their portfolio according to how much risk they are comfortable taking at different points in their life.
Lifecycle investing is based on the premise that you can take more risks the longer your investment time horizon. Vice-versa you should take less risk the shorter your investment horizon.
As you move through your investment life the balance of assets in your portfolio should change accordingly.
If you start saving for a pension when you are younger you still have a lot of earning time ahead of you. So, if your investments don’t go as planned you still have income and time to recover.
You also have longer to invest so the peaks and troughs should iron themselves out over time.
As you can see by green line below over the last 30 years the FTSE100 has risen (not adjusting for inflation or compounding dividends). The longer your investment time horizon the less you need to worry about short term volatility.
As you get older, closer to retirement or retire, you cannot afford to lose a substantial part of the wealth you rely on to live. You do not want to have the risk of the market suddenly dropping.
As you can see, by the red lines over short periods you would have lost a substantial part of your wealth. The shorter the time horizon the less the risk you might want to take as short term volatility could dramatically affect your standard of living.
This is often referred to as sequence risk. Lifecycle investing can help reduce that risk.
What are the different lifecycle stages?
The different types of portfolio allocation are usually called cautious, moderate, balanced, growth and aggressive. With the split of equities to fixed income as follows:
- Aggressive 100
- Growth 80/20
- Balanced 60/40
- Moderate 40/60
- Cautious 20/80
Most investment platforms have readymade portfolios with the different allocations for you to choose from.
For Example, Vanguard offer LifeStrategy Portfolios
The most common is the balanced portfolio with a mix of 60% shares and 40% bonds. Historically it has offered some protection when the markets are in a downturn and growth when the markets are going up.
There are many ways to allocate assets in your portfolio beyond the traditional mix of equities and fixed income, but this traditional method is a good starting point.
How to choose your investment lifecycle stage
An old rule of thumb has been to hold the percentage of bonds according to your age.
That is a huge generalisation and really it depends on your goals, investment time horizon and attitude to risk.
A retiree who depends on their investments to live might choose a cautious asset allocation which is less volatile to protect their capital.
Whereas a grandparent with extra cash investing for a grandchild might choose an aggressive portfolio with 100% equities.
As your goals change so will the balance of the assets in your portfolio.
Lifecycle investing Conclusion
Lifecycle investing is an effective way to manage your portfolio as you move through different stages of your investment life.
To learn more about asset allocation and how to build a balanced portfolio I strong suggest you read A Random Walk Down Wall Street.
If you are unsure about what is the best portfolio don’t be afraid to contact a financial advisor.