What Is Age-Based Investing And How It Can Be Smart

Age-based investing is a life-cycle investment strategy that advocates changing the composition of your portfolio as you age and approach retirement. The premise is that younger investors will pursue an aggressive growth strategy to build wealth, diversify into a mix of assets in middle age, and finally transition into a conservative income-focused strategy in retirement.

Before You Start

You need a plan and a goal before embarking on any investment strategy; age-based investing is no different. Answering these five questions will give you an investment roadmap to get you to your destination:

• GOALS: An age-based investing strategy doesn’t have to be for retirement. Your goal may be buying a first or new home or funding a child’s education. This often means setting a shorter deadline than if you were planning for retirement.
• TIME HORIZON: When do you need the money from your investments? This usually depends on your anticipated retirement date but could be at any time you decide.
• RISK TOLERANCE: Even though the standard age-based investing strategy calls for being almost completely invested in growth stocks when young, your personal risk tolerance could make that position uncomfortable. Conversely, you may wish to keep your portfolio heavily weighted towards growth stocks well into middle age to boost returns. A proper financial education, such as our Winning Trader Series course, can better inform you on which investment strategies align with your risk tolerance.
• CURRENT AND FUTURE INCOME SOURCES: Your income and expenses will dictate how much you can put toward investing for retirement. Through the miracle of compound interest, the more money you can invest, and the sooner you invest, will pay off down the road. If you will only have Social Security, your investment returns will need to be higher.

An Age-Based Investing Roadmap

The typical age-based investing strategy goes something like this:

• 20s TO 40s: Growth phase. Invest 80% to 90% in stocks, leaning heavily or completely into growth stocks. You’re trading higher risk for greater returns early to build an investment war chest. You will still be young enough to recover if the market goes south.
• 40s TO 60s: This is the time to dial back on a total equity position and diversify. Many investors will transition to a 60/40 stock and bond mix here. The aim is to continue earning returns but not at the risk of being wiped out by a market crisis or recession. This is also the time to consider adding dividend stocks to your portfolio and reinvesting those dividends to grow your position.
• RETIREMENT PHASE: You no longer have the time to recover from big bets gone wrong. This is the time to reduce risk and emphasize the preservation of the capital you have accumulated earlier in life. A popular option is to transition to a 40/60 portfolio, emphasizing dividend stocks and bonds—assets that provide income without needing to be sold.

How Much Should You Save?

Many people have no idea how much they should save to retire comfortably. One commonly used chart has the following recommendations, using your annual gross salary as a benchmark:

• By age 30: 1x your salary
• By age 35: 2x your salary
• By age 40: 3x your salary
• By age 45: 4x your salary
• By age 50: 5x your salary (consider moving to a 60/40 allocation.)
• By age 55: 6x your salary
• By age 60: 7x your salary (begin moving to an income-focused portfolio)
• By age 65: 8x your salary

This is a best-case scenario. It doesn’t make provisions for serious medical events or other unforeseen circumstances. Don’t beat yourself up if you can’t hit these marks. Your target is to be able to fund your retirement at the level you desire or require. The only result that matters is meeting that end goal.

One metric for how much you will need to save is the commonly used “4% Rule.” Under this rule, you withdraw no more than 4% of your retirement savings a year and let the remainder of your investment continue to make money. With a large enough portfolio, tapping your withdrawals in this manner should make your retirement money last for years since you keep it invested and earning money.

One Size Doesn’t Fit All

You don’t have to invest in a certain way just because the boilerplate version of age-based investing says you should. Some people are more risk-averse than others, and some like to aim for the big payout, no matter what the guidelines say. Your time horizon will also inform your decision to take on more or less risk. The older you get to retirement, or the closer your deadline looms, the less time you have to recover from an investment mishap.

Broadly stated, there are three types of investment strategies:

• AGGRESSIVE: The aggressive investor aims to maximize growth, no matter the risk. This high-risk strategy can often be attributed to an abbreviated time horizon they’ve chosen. Commonly, they are looking to maintain this investing stance for approximately 15 years.
  Sample allocation: 95% stocks, 5% cash.
• MODERATE: The investor with a moderate risk tolerance aims for growth but not growth at all costs. Investors with a moderate appetite for risk commonly choose a traditional 60/40 portfolio. The average time horizon for these investors is about 10 years.
  Sample allocation: 60% stocks, 35% bonds, 5% cash.
• CONSERVATIVE: Conservative investors are notably risk-averse, focusing on income and wealth preservation rather than growth. Dividend stocks and bonds are preferred assets for their income potential and lower volatility. This is the stance most investors take at retirement.
  Sample allocation: 20% stocks, 50% bonds, 30% cash.

Age-Based Funds

Age-based investing isn’t a “fire and forget” strategy like investing in an index fund. Investors need to monitor their holdings and adjust their portfolios when needed according to changing market and economic conditions. If you would prefer a hands-off approach, there are age-based funds that you can invest in. Also known as target-date funds, these funds will automatically rebalance at certain dates. They also have an end date that is set based on when the plan begins.

The advantages of age-based funds include paying into the fund without worrying about what individual assets you should invest in, or remembering when and how to rebalance your portfolio.

The drawbacks of age-based funds include the possibility of earning less than you would by investing directly in the market and outliving the money in the fund. The fund ends at a date predetermined when it was created, regardless of your financial situation.

“It’s More Guidelines Than Actual Rules”

Millions of people have used age-based investing to structure their long-term investments, each putting their own spin on the idea according to their acceptable risk level. When deciding on your investments, remember that the asset mix for each category are just guidelines. Just because it sets a 60/40 asset split for midlife investing doesn’t mean you must hit that percentage exactly. The details are up to you. Remember, though, that age-based investing is popular because it works when used correctly.