A reader recently asked — in response to the article, Why are you recommending index funds but not investing in them yourself? — “What is the equity exposure of your retirement portfolio?”. I said, “It is currently about 62%.” He said, “is that not too much equity at your age (48, well, almost 49)?” There are common misconceptions about how much equity a middle-aged person should hold— a discussion.
As we begin investing for retirement, say in our mid-thirties, we are clueless about at least two factors: (1) how much volatility we can tolerate in real-time and (2) and how our risk appetite and goal priorities change. As we keep investing, the lessons we learn are innumerable and incredible.
As mentioned in the article – There is more to retirement planning than building a large corpus! – my approach to retirement planning in the last decade has undergone a sea change. Also see: How to build the ideal retirement portfolio. While this article covers the technical aspects of my learning, here is how my personal goals changed.
Like most people, the first time I used a retirement planning calculator, I got the “you do not have enough money to invest” feeling. This may be disheartening, but we do not know how our future cash flow will change. In the 20s and 30s, our main goal should be to try and increase our main income as much as possible. In the 40s and 50s, while regular investing continues, the focus can shift to creating passive income streams that last a lifetime.
I was amazed by the power of continuously increasing our investments and what a sudden market rally after years of no return can do to your portfolio and your station in life! See: Why increasing investments each year is crucial for financial freedom.
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When we begin, we cannot appreciate the power of these forces. Those who put their head down and invest without immediate expectations stand a better chance of success.
As the networth builds from 1X to 5X to 15X to 30X (X = annual expenses that will persist in retirement), your approach to risk and goals change. Of course, one cannot make arbitrary changes to a plan. The core plan is clear. My retirement age is 65, and if I punch my numbers in the robo advisory tool, I can afford to hold on to 60% for at least the next few years, as shown below. Note: The max retirement age in the template is 60, as everyone should be ready to retire by then!
Now there are two different ways of viewing this result.
- If I already hold 60% equity – I am – see: Rebalanced my retirement portfolio after 13Y, a crash & recovery! – then not only am I comfortable with this suggestion, but I also think of tweaking it as below.
- If I am middle-aged and hold little or no equity, there are only two choices: Either DIY a custom asset allocation schedule (the results will be tough to stomach!) or consult a SEBI-registered fee-only advisor.
So 60% equity holding may seem right or wrong depending on how much we currently hold. Also, percentages mean little. A person may only hold 40% debt, but what is it currently worth?
I had often talked about 30X as the threshold of financial freedom. That is a networth of 30 times the current annual expenses that would persist in retirement. This means for zero real return (inflation = post-tax overall portfolio return after retirement), the corpus would last for 30 years.
It seemed like a big deal before I crossed this 30X mark, but my targets have changed today. “Can my debt portfolio hit the 30X mark?”, “Can I afford to hold on to 60% equity all my life?” I do not have answers for these, but my point is, after years of investing, our outlook changes.
Our goal targets change and how we look at asset allocation and risk management change. We cannot anticipate this, so naturally, others cannot as well. Certainly not from percentages.
So, how much equity is “right” for a middle-aged person? This largely depends on their capital market experience. Those with experience may make the mistake of holding too much equity before and after retirement! That is just as risky as 0% equity. Even the experienced should not exceed 70% equity before and 50% equity after retirement (assuming the corpus is considerable).
Now if middle age is 40-50 and retirement is 55 (for those in corporate, 50 may be a better estimate than 55!), there are not more than 15-10 years of investing left.
This is a difficult problem: no equity experience and only 10-15 earning years left. What would you do? I would recommend getting the equity asset allocation at least up to 40% as quickly as possible, say within three years. Get ready to hold at least 20% equity after retirement.
This brings us to another question: how much equity should we hold after retirement? The goal-based portfolio management lectures present interesting and counter-intuitive evidence on this subject.
One of the most important lessons on investing I have learnt over the years is this: portfolio management has two components: (1) a well laid out plan that takes into account as many of the knowns as possible; (2) the ability to look at a developing situation (crash, recovery or sideways market) and make course corrections. There is no well-defined set path here. We have to create our own as we go along. And when we do, we tend to redefine the goals as well.