What is life stage investing?
Life stage investing means holding more in stocks (higher volatility, higher potential return) during your younger years, and more in bonds (lower volatility, lower potential returns) as you approach and pass through retirement. The younger you are, the more time you have to ride out volatility and benefit from the rewards of the potentially higher returns of a higher stock allocation, during that life phase. Once you are approaching or in retirement, you have less time to recover from significant volatility, so a lower-volatility portfolio is generally appropriate. Also, emotional investing may increase somewhat as you age, especially as you stop working and rely on your retirement portfolio for retirement income, so higher volatility risk may feel even higher later in life, which may decrease your ability to stick with a higher-volatility portfolio for full recovery. When you are spending from your retirement account during retirement, the money spent is no longer there to experience the eventual market recovery, if withdrawn during a market downturn, so more moderate or conservative investing reduces “selling at the bottom” risk.
Note also that a well-devised retirement strategy also relies on significant and consistent saving during your pre-retirement years (you can’t solve a savings problem by investing!), so that you don’t feel the need to take on more risk in an attempt to increase return right before retirement to make up for a lack of saving. WealthStep’s advice engine will estimate your risk tolerance and tell you what a typically appropriate portfolio would be for your life stage. Your final portfolio selection should consider your life stage, risk tolerance, as well as your ability to save the amount recommended (see the Planning/Saving Advice module), and other considerations. If you have a very low volatility risk tolerance, and invest more conservatively than your life stage warrants, be aware that you will need to save significantly more to achieve the same “nest egg” goal or retirement amount. Or, if you don’t save more, you subject yourself to greater inflation and longevity risk. The pattern of using generally recommended portfolios by life stage may not be perfect for everyone, but if used in conjunction with disciplined investing and sufficient saving, are likely to improve your long-term financial independence and retirement readiness. Also, if your in-retirement spending will be sufficiently low relative to your assets, and/or you will have a sufficiently large pool of assets relative to your spending needs, you may be able to take on less volatility risk earlier in life and still meet your spending goals. If you believe that’s the case, it may be necessary or helpful to consult a fee-only, conflict-of-interest-free financial planner to help you evaluate your special circumstances. Watch the Financial Independence video and review other FAQ’s to develop a better understanding of the risks and trade-offs, to make sure you take the right risks in the right proportion, to successfully achieve your retirement goals.