Using an age based formula to determine what percentage of funds to allocate to equities versus fixed income is crazy. This formula suggests choosing your investment allocations where a person deducts their age from a number such as 110 to get your equity allocation and fixed income allocations. As an example, if you were 50 years old your formula would be 110 – 50 = 60, so you would allocate 60% of your funds to equities and the remaining 40% to fixed income.
Challenging the Age Based Formula
I recently challenged this age based formula by back testing it over a fifteen year historical period. The portfolio was re-balanced each year with the aged based allocation formula above starting at age 45 and ending it at the beginning of the investor’s age of 60. Using two simple major index based etfs, the SPY for equities and the TLT for bonds, we had the following results.
If a person used this concept over the back tested fifteen year period their portfolio returns would have been approximately 140% less than the S&P index’s return for the same time frame. If the tested investor’s starting account balance for the portfolio was $1 million dollars then using the age based allocation strategy would have cost the investor $1.4 million dollars of missed out on returns over the fifteen year period versus just being invested in the index alone. A simple 60/40 asset allocation without periodic rebalancing beat the age based concept by over 100% for the same fifteen year time period run.
There has been a movement for target based investment funds as a method to lower an investor’s exposure to equity volatility as they age. Many of these age based target funds use the same concepts within their investing strategies. These target funds vary in composition, but the ultimate is the market doesn’t give hoot about your age, so building an allocation based upon your age could cost you.
There are many ways an investor can lower volatility and risk without sacrificing comparable market returns. Lowering your potential invested asset returns will shorten the length of your money lasting. Old concepts don’t always work the best. Allocation strategies can have a big effect on returns, so choose smartly. Our Over 50 Smart Posts have articles and ideas. Our allocation strategies are proprietary.