Age plays a major role in asset allocation decisions as our circumstances and available resources change over time. All of us have two different life spans, namely, physical life span and earnings life span. During our earnings life span, we convert our efforts and human capital into earnings and the same is used to meet our daily needs as well to save for the future. Researchers categorise investors by different groups. Let us see at which stage you are in.
Early savers are those investors who start investing in the beginning stages of their careers and families. They have the advantage of abundant human capital, energy and plenty of time for saving. Early savers do make investment errors but they are not hurt much as they have not invested too much money and have enough time to make up for their losses.
Mid-life wealth accumulators
Mid-life accumulators are those investors who are established in their careers and, perhaps, family life and have accumulated real assets such as car, home, etc. They know what is their career and family potential and can start to plan for a comfortable retirement. They realise that their earning life span is about half over. They start to think of a viable and sustainable investment policy which is critical to reach their retirement goal. Generally, avoid aggressive investing experiments during this period of your life as it is the right time to treat retirement investing as a serious business.
This stage comprises people who are nearing the end of their working years and are preparing to retire, or have recently retired and are living an active post-retirement life. In India, just 10 years prior to retirement, many people become perplexed about questions such as when to retire, whether they have enough money to retire, and what amount of money they can safely withdraw from savings so that they do not run out of money on retirement. Most people who are nearing retirement are in their peak earning and savings years. So, asset allocation decisions need to be based on the amount saved and the accruals from those savings needed each year during retirement. Often, this is a period of risk reduction in your portfolio.
Asset allocation for mature retirees can range from very conservative to moderately aggressive. For those with modest means, asset allocation should be conservative. For the more affluent, asset allocation decisions often include the needs of those who will inherent wealth and that leads to a more aggressive mix.
There is a wide range of differences among these categories. These include career challenges, family situations, risk tolerance differences based on investment experience, health issues, and personality strengths and weaknesses. Framing investment decisions in terms of these four life cycle phases helps lead life happily even after retirement.
The writer is associate professor of finance & accounting, IIM Shillong