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What Role Does Equity Play In The Portfolio Of An 80-Year-Old?

Everyone in the markets is privy to the famous “100 minus age” rule of asset allocation. For those who are not, it’s a thumb rule used to compute the ideal component of equity in an individual’s portfolio based on their age.

So an 80-year-old individual must supposedly have (100-80) 20% allocation to equity. While the underlying logic of the rule to dissuade older people from taking more risks directionally makes sense, there are a lot of factors ignored by the rule, sometimes leading to faulty investment decisions.

We will discuss such factors which will challenge our preconceived notions on the topic and help us better appreciate underestimated role that equity can play in an old person’s portfolio.

Also Read: Asset Allocation: Considering Age Factor for an Investor

Risk appetite is one such factor that comes to mind for a novice investor, but a more critical factor would be financial goals.

Say for example a person is aspiring to buy a car 10 years down the line which – keeping in mind their savings rate – requires a 12-13% expected returns on funds allocated. However, the person has never had any exposure to assets like equity, which tend to be volatile. In such a case, they have no other option but to take some exposure to equity to achieve targeted IRRs, which would be otherwise unattainable if all the investments were made in fixed income securities/alternatives.

Therefore, financial goals as a factor take precedence over risk appetite. Under financial goals too, microanalysis of the duration and flexibility of the goal must be done to decide which financial asset more suits the circumstances of the investor.

For example, a goal to buy a luxury car 7 years down the line can be financed by equity investments since the goal is that of a long time horizon and even if we miss the goal by 10-20% owing to negative surprise, it wouldn’t have a significant impact on our lives (flexible).

Putting this knowledge to practice, we identify what could be possible financial goals that an 80 yr old individual have-

  1. Funding lifestyle (everyday expenses)

80 year old would want to have enough invested for this goal so that they do not outlive their portfolio while keeping up with inflation.

Since this is a goal with immediate maturity and low flexibility (we can’t risk miscalculating our portfolio by a huge margin), we would want most of it to be funded by fixed-income securities/alternatives.

  1. Pass on inheritance money

This money is earmarked with no end goal in mind besides wealth accumulation, therefore has a longer time horizon and high flexibility, making it a perfect candidate for equity investments

Summing up, if an old couple needs X amount to survive in their hometown – applying the 4% rule – they can park 25X in fixed income securities/alternates which may finance their lifestyle indefinitely. Anything above that amount in the portfolio can be allocated to equity, allowing the wonders of compounding to do the magic and helping their offsprings inherit huge sums.

What Role Does Equity Play In The Portfolio Of An 80-Year-Old?

WealthDesk
What Role Does Equity Play In The Portfolio Of An 80-Year-Old?

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WealthDesk

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