Some life events took place this week, births, an anniversary, that brought to mind a way of looking at investing that I thought would be good to share with my huge reading audience. I call this, ta-da, age-related risk investing, and I do not claim to have originated this approach, although as far as I recall I did back when I was finishing up graduate school 15 years ago. I will go into more details in future entries but here are the fundamentals.
The basic premise of ARRI is that the younger you are, the higher the level of risk you should be willing to take in your investments. As you age, the level of risk in your portfolio is lowered until there is essentially no more risk. There are two key considerations, that higher risk often means higher reward and that at some point one no longer has enough working years left to earn one’s retirement nestegg. The goal of this strategy is to ensure a sufficient amount of savings to fund a 30 year retirement although I won’t go into how to calculate that amount here. Should the strategy work very well, an individual could consider retiring at a younger age.
ARRI splits one’s investing life into three stages: under 45 years old, 45-55, and over 55. People under 45 should essentially go for investments that have as much risk as possible, common stocks. If an individual is willing to take some time to educate themselves, options and futures should be added to a portfolio. People at this stage should have no, or nearly no, low risk investments like government bonds. As mentioned above, high risk often brings higher reward and, in this age range, people still have time to take chances. Historically, common stocks have provided the best return over time and should be the main investment vehicle; picking specific stocks requires an effort to do some research and analysis, as blindly following an individual newsletter or Wall St. analyst has rarely been successful.
The middle stage is a transition period. Some risk is still worthwhile, given the value of compound interest/return. ARRI calls for gradually changing the risk profile of the portfolio over the 10 years, so that at the end their is essentially no risk left. Some discipline is required here so that the transition is gradual although moving in 10 equal steps is also too strict. By age 55, the entire portfolio ought to be in investment grade bonds, preferably a mix largely slanted towards medium term government issues. There is no risk-free investment, of course, but the biggest foreseeable risk in American government bonds is inflation and there is little safe harbor from this risk that does not entail others.
Some people look at the stock market as a game, one they enjoy playing. I know because I have a close relative who does and as well off as this person is, the question could be asked as to how much better their account would otherwise be. For these individuals, the discipline of ARRI may be difficult if taken to an extreme. However, as long as one keeps the underlying goal (funding for 30 years of retirement) in mind and has a separate account for this purpose, there is no reason not to keep playing.