The Flight Path Approach to Age-Based Asset Allocation

[Rick Ferri]

Asset allocation models based on an investor’s age tend to be inherently flawed. They state that young people should be heavy in stocks and old people heavy in bonds. The idea sounds passable, but it doesn’t fit how many people actually act or what they may need.

Age-based models assume all young investors have a high risk tolerance and can emotionally handle bear markets. They also assume retirees should continually reduce equity exposure the longer they’re in retirement. I don’t support either assumption.

That’s why I propose a different way of thinking about age-based asset allocation. I call it the flight path model because the allocation to stocks resembles the flight path an airliner would fly. An aircraft take offs, climbs to altitude, cruises at altitude for a long distance, descends into a destination and lands.

A flight path asset allocation works the same way. When a person is young, their allocation to stocks is moderate. Equity allocation increases over time as experience increases. At some point, stock allocation hits a cruising level based on each person’s needs, experience and tolerance for risk. Finally, the allocation descends as retirement approaches and lands at a moderate risk level.

For more details includes an example, please read my latest artcle The Flight Path Approach to Age-Based Asset Allocation

Rick Ferri

[allsop]

Very nice article.

[CaliJim]

This is a very interesting idea.

Rick's experience as a young investor is very similar to my own. I invested my first $3000 in 1980. Lost 30% of it. Sold. Then I mostly stayed out of the markets entirely for nearly a decade.

[Taylor Larimore]

Bogleheads:

This is important "out-of-the-box" thinking from a very knowledgeable and experienced Boglehead advisor. I anticipate a lively discussion

There is more than one road to Dublin.

Best wishes.
Taylor

[freebeer]

Rick,

Thanks for posting. What's the data that supports that proposition that gradually increasing a new investor’s allocation to equity "increases the probability that they will stay the course in a turbulent market"? That's a pretty unequivocal statement but there's no reference in the paper.

[Rick Ferri]

Paul made an interesting post on other conversation about this topic:

A small minority of young investors can actually hold 100% stock and they do not see why anyone can't. It's hard to ague with the record though. Remember the sharp criticism of TR funds after the 2008 crash? Young investors who were put into high equity TR funds by default were stunned by their losses and they did pull out, and they complained, and TR funds came under the scrutiny of the regulatory agencies. We will always hear from a newer investor who did hold, but when looking at the big picture, Rick is absolutely right.

This is something I've noticed about Rick Ferri a long time ago--he is a professional advisor like some others on investment forums, but Rick, unlike others, is constantly focused on providing helpful advice for the average investor. Of course, this is also what drives John Bogle and the Bogleheads.

I put both my nephews - who are in their early 20s - in a Vanguard Target Retirement fund that's 90% equities. They pay no attention to the fund. It could drop 90% and they wouldn't care!

Maybe one aspect of their indifference is, it's not their money. It might benefit them more if you could help them learn investing basics.

Paul

My question is this, has there EVER been any data published to support the assumption that young and inexperienced investors who have a high allocation to equity have remained invested during their first bear market? I only know what I've seen occur.

Also, don't misundestand my article as saying NO young investor should be high in equity. As Paul wrote, my article is aimed at the average investor. Of course, if you ask any young person in the 20s, they are all above average!

Rick Ferri

[BB23]

This is an interesting idea, for sure, but I wonder whether it is trying to patch something that is really an issue of education.

I'm a pretty young investor (30 yo), and there was definitely a period for me where I tried to think things out on my own, in terms of portfolio building and retirement strategies. Luckily, I didn't do any damage to my longterm prospects figuring that out, but it was a bumpy road to where I am now. I remember the moment when I went from being panicked about the 2008 market downturn (oh no, all that money in my retirement account for work!) to seeing the crash as an opportunity (in the long run, I can grab equity for a lower price and have a much better shot at buying a house down the line).

But I think if you can hammer home 3 key points to young investors:

1. Time is hugely on your side
2. The "total net worth" of your current retirement assets pales in comparison to what you'll have in the future, so don't get fixated on that number.
3. Retirement money is truly funds you are putting away for 40, and 50 years in the future

then the 90/10 split you see at the start of Target Retirement funds is a good thing, especially with a lot of young people I know who are investing in such a vehicle on autopilot.

The hard part is those three rules are easy to tell a young investor, but it's very hard for them to understand them enough to create conviction in their subsequent action: long-term retirement investing is a process that many people don't have a great frame of reference for. But teaching something in the abstract is very hard.

One thing that might be helpful would be a computer program that combines that aging software (where you see your own face 30, 40 years from now) with a simulation of your own voice, passing down some of these lessons

There is a great quote from Bernard Palissy*, a French Renaissance potter, that goes as follows. It is from a essay he wrote about a conversation between Theory and Practice, in which Theory is trying to convince Practice to give up all her secrets:

"Even if I used a thousand reams of paper to write down all the accidents that have happened to me in learning this art, you must be assured that, however good a brain you may have, you will still make a thousand mistakes, which cannot be learned from writings, and even if you had them in writing, you would not believe them until practice has given you a thousand afflictions."

*Palissy was an amazing individual. Held a piece of Chinese porcelain in his hand once, and then spent a dozen years experimenting, by trial and error, until he was able to make it for himself.

[555]

"This is important "out-of-the-box" thinking ..."

I can't find a reference, but I am sure I've heard this idea a few times before, so it is nothing new.

The article says

They [age-based models] also assume retirees should continually reduce equity exposure the longer they’re in retirement.

That's almost universally false. If you look at almost any commonly used glidepath, it moves to a constant allocation during retirement.

I'll reiterate what I said in the other thread.
http://www.bogleheads.org/forum/viewtop ... 0&t=104739

I emphatically disagree with what Rick Ferri, and the many others who have said the same thing in the past; the idea is nothing new. Young investors will generally be better off investing aggressively, rather than conservatively, provided they don't bail out in a down market. (I'm sure we all agree about that.) What Rick Ferri and others before him are basically saying is that young investors should forgo the higher expected return of stocks, because he's worried they might do something stupid. But it's better advice to tell young investors not to do something stupid.

I think if you are advising a young investor to start investing conservatively, you need to be upfront and explicit and explain that they would generally be better off investing more aggressively, and that it will typically cost them a lot of money being too conservative, but that you are advising them to start investing conservatively because you fear that if you advise them to (1) invest more aggressively and (2) stay the course, that they will do (1) but not (2). You are basically not trusting them to follow the advice, and you need to explicitly say this to their face so they really understand what the choices are. They need to understand that the advice they are being given is not what they should do, but instead has been modified due to some `behavioral' assumptions.

[Note `you' here means any generic person who would give this advice.]

[Rick Ferri]

I can't find a reference, but I am sure I've heard this idea a few times before, so it is nothing new.

If you can find a reference, please post it. I've been aound for a long time and have never read an article or study suggesting that young people have anything other than a high equity allocation.

They [age-based models] also assume retirees should continually reduce equity exposure the longer they’re in retirement.

That's almost universally false. If you look at almost any commonly used glidepath, it moves to a constant allocation during retirement.

Glide paths are designed to reduce equity to a "target date" not an age, and then it's assumed that some other plan happens. The allocation after the target date is not discussed in the literature.

What Rick Ferri and others before him are basically saying is that young investors should forgo the higher expected return of stocks, because he's worried they might do something stupid. But it's better advice to tell young investors not to do something stupid.

Tell young people not to sell in a bear market is a far cry from what many actually do. It works sometimes if a strong role model is in the mix, but then, even one of my 20+ year old children sold in 2008 without telling me.

The best equity allocation for a young person isn’t the one that's highest in equity; it’s the one that they stick with through all market conditions.

Rick Ferri

[abuss368]

What a fantasic artilce and a very interesting way of looking at things.

Thanks Rick!

[LadyGeek]

The Target Date Funds are the perfect choice for those who don't understand, or won't pay attention to, investing concepts.

How do you create an autopilot fund with this approach? Without a set-and-forget option, I don't see this interesting idea moving forward. Rebalancing is complicated to the point that many investors simply won't do it.

Can they learn? Sure. But, you can say the same for almost any topic. Will rebalancing actually be done? No.

[555]

I can't find a reference, but I am sure I've heard this idea a few times before, so it is nothing new.

If you can find a reference, please post it. I've been aound for a long time and have never read an article or study suggesting that young people have anything other than a high equity allocation.

I googled and couldn't find anything, but I'm sure I've heard the idea before. There was this post in the other thread.

Great Britain has also recognized the failure of very high stock allocations for inexperienced, untested investors. They have modified the default target retirement funds so they begin with a lower stock allocation and then rise as the investor become more experienced.

“In the Foundation phase, which has been the victim of some misunderstanding, we still have the objective of matching inflation, and we have a sizable allocation to equities, but not as much as in the Growth phase. We have a risk target in the Foundation phase of 7% volatility, versus 11% in the Growth phase. For comparison, an all-equity allocation would have 18% volatility,” Todd said.

http://retirementincomejournal.com/issu ... ch-to-risk

Paul

[brick-house]

Rick Ferri wrote:

If you can find a reference, please post it. I've been aound for a long time and have never read an article or study suggesting that young people have anything other than a high equity allocation.

Great article. As I read the article, especially the graph on the "flight path" - I was reminded of Jim Otar's Unveiling the Retirement Myth book.

He has a concept of seed money formation (Chapter 19 Optimum Asset Allocation Accumulation Stage) for younger investors and his lifetime asset allocation path is similar to your "flight path."

[555]

Rick Ferri wrote:

If you can find a reference, please post it. I've been aound for a long time and have never read an article or study suggesting that young people have anything other than a high equity allocation.

Great article. As I read the article, especially the graph on the "flight path" - I was reminded of Jim Otar's Unveiling the Retirement Myth book.

He has a concept of seed money formation (Chapter 19 Optimum Asset Allocation Accumulation Stage) for younger investors and his lifetime asset allocation path is similar to your "flight path."

Maybe that's what I was thinking of.

[camontgo]

Hi Rick,

Is ability to "stay the course" more closely correlated with age, temperament, or education? The flight path approach focuses on age, but I think the other factors are a least as important, and perhaps more important. Are there any studies which try to quantify trading frequency vs. age.

Some young people only seem to be able to learn things the hard way. You are right that most won't listen to advice to "stay the course" through times of market turmoil, but they are also unlikely to listen to advice telling them to keep some money on the sidelines until they learn the game. Would you have listened to the flight path advice when you were a young officer?

I think the people who would most benefit from your alternative path are also the ones who are least likely to follow it.

[Jay69]

Rick

I like the idea, it’s something this 40 something year old has really adopted in some fashion already.

If a young person drops in from the top or comes up from the bottom I think it’s mostly just plain education that’s going to enable them to find the cruising altitude. Most of us will find the cruising altitude one way or another, sooner the better.

The key is at what age are you going to know that you don't know everything knowing.

[Jerilynn]

Tell young people not to sell in a bear market is a far cry from what many actually do. It works sometimes if a strong role model is in the mix, but then, even one of my 20+ year old children sold in 2008 without telling me.


Rick Ferri

Relatives! I've been talking with my 78 yr old mom for at least 20 years regarding investments and thought she was on-board with typical Boglehead philosophy. Come to find out a few months ago she bought a tax free high yield bond fund because the salesman told her about the high (what turned out to be the distribution) yield. Of course it's long term. And to make matters insanely worse it had a 5% front end load. Arrrrrrrrrrrrrrgh!

[umfundi]

Bogleheads:

This is important "out-of-the-box" thinking from a very knowledgeable and experienced Boglehead advisor. I anticipate a lively discussion

There is more than one road to Dublin.

Best wishes.
Taylor

Rick is wrong. It seems he presumes that everyone has to make their own mistakes, they cannot be taught.

I personally believe that EVERYONE should be invested 75/20/5% stocks/bonds/cash except for their 5-7 year needs.

I find it very interesting that my risk tolerance has increased (a lot) as I have aged. Market goes down 40% tomorrow? Been there, done that. 60%? I was there in 2008. Came back a lot stronger than I went in, by staying the course.

The risk is that you will not reach your end goal. It is not that you will suffer a near-term decline. You probably will suffer such a decline. It does not matter.

Keith

[peppers]

Case in point. One son, married, late 30's. Their investment portfolio...no bonds....100% equities....all international. Investing about 12 years. Have never sold, just contributing yearly. I have asked him to lighten up but he's stubborn like his father. I take comfort in the fact that the other three adult children are more balanced in their investments. I guess time will tell.

[Rick Ferri]

Bogleheads:

This is important "out-of-the-box" thinking from a very knowledgeable and experienced Boglehead advisor. I anticipate a lively discussion

There is more than one road to Dublin.

Best wishes.
Taylor

Rick is wrong. It seems he presumes that everyone has to make their own mistakes, they cannot be taught.

I personally believe that EVERYONE should be invested 75/20/5% stocks/bonds/cash except for their 5-7 year needs.

I find it very interesting that my risk tolerance has increased (a lot) as I have aged. Market goes down 40% tomorrow? Been there, done that. 60%? I was there in 2008. Came back a lot stronger than I went in, by staying the course.

The risk is that you will not reach your end goal. It is not that you will suffer a near-term decline. You probably will suffer such a decline. It does not matter.

Keith

Keith, you're saying that every investor is exactly the same as you in every way, that all people of every age and background have the same expectations, the same goals, the same ability to handle risk, and basicaly the exact same genetics.

Rick Ferri

[danieljquirk]

I like the approach Rick!

I think another effective approach can be education before the fact. I think it is fine for young investors to be in mostly equities, as long as they are fully informed about the risks of something like a 50% drop (i.e. 2001 and 2008). But the key is to get them excited about a bear market because a bear market is the greatest gift in the world to a young investor. If you are continuing to add at lower prices when the market tanks, you will be able to turbo-charge your long-term returns. But education before the fact is the key. I have been starting to communicate this message to younger investors and it resonates. Not for everyone, but the idea adding at lower prices does appeal to a lot of people. But you must be prepared and educated ahead of time. With two relatively recent bear markets, where we've seen subsequent rebounds, I think that is actually easy. Education, education, education....

That being said, I think very few people should be 100% equities. 10% in bonds is quite reasonable and appropriate for even the youngest and most aggressive investors.

[Rick Ferri]

I've wrote another article with data to further support my position that young people have different views on risk than more experienced investors:

Perils of Crashing Through Risk Tolerance

Rick Ferri

[magneto]

Thanks Rick. As a retiree I found the article aligned with doubts I had been having about the age in bonds guideline.

[YDNAL]

That’s why I propose a different way of thinking about age-based asset allocation. I call it the flight path model because the allocation to stocks resembles the flight path an airliner would fly. An aircraft take offs, climbs to altitude, cruises at altitude for a long distance, descends into a destination and lands.

A flight path asset allocation works the same way. When a person is young, their allocation to stocks is moderate. Equity allocation increases over time as experience increases. At some point, stock allocation hits a cruising level based on each person’s needs, experience and tolerance for risk. Finally, the allocation descends as retirement approaches and lands at a moderate risk level.

One size does NOT fit all - regardless of the "path" suggested (or forced) for all.

Having "moderate" Equity risk when young is counter-productive (in general) and I see no benefit in this for investors with the most human capital, the most time to recover from Equity corrections, and the most to benefit from riskier/higher expected return Assets they can hold for the longest period possible.

[umfundi]

Keith, you're saying that every investor is exactly the same as you in every way, that all people of every age and background have the same expectations, the same goals, the same ability to handle risk, and basicaly the exact same genetics. Rick Ferri

Rick,

That's not what I meant. I was trying to say that the behavioral issues should be more explicitly addressed.

Keith

[retiredjg]

I like the idea a lot. I agree it is thinking outside of the box. I also agree the idea has been mentioned before.

Awhile back, someone mentioned a similar idea and said it was discussed in Jim Otar's book (haven't read it so I can't say for sure). I liked the idea - it made a lot of sense to me (then and now). And I recall suggesting it myself a handful of times for people who wanted to be aggressive but were afraid of the possible losses.

I'd have to disagree with the idea that young investors would generally do better invested in more stocks. In the early years, when the contribution grows a portfolio more than the actual investment grows the portfolio, it is unlikely to matter at all what a young person is invested in.

I agree that getting experience under one's belt, watching your tiny portfolio bob up and down with the market, could be crucial in helping people stick to a plan when they actually hit the bad times. But they have to get through the first bad time without selling - an easier feat with a lower stock allocation. Once that first bad time is over, many people should be able to increase their equity portion safely.

[k66]

Personally I have never found the "X minus Age" allocation approach especially rational or persuasive (essentially no real argument is ever given except that it is apparently some accepted industry norm...). For example, it is often presented hand in hand as a means of establishing portfolio security (or protection from market volatility) in one's later years. However, when you run Monte Carlo simulations, the "safest" results never occur at either end of the Bond:Equity splits - the safest (most enduring) portfolios are usually mid-range splits... 60:40 to 40:60.

Yes - MC simulations have their drawbacks, but one thing they do tell you is the relative strength or "robustness" of a given portfolio arrangement.

Currently I am 70% Eq and only 20% Bond (+10% REIT) ... only because I see huge upside to Equities in the next decade (my personal retirement horizon) and much less for fixed income investments. In retirement I would likely move to a 50:50.

[Rick Ferri]

Keith, you're saying that every investor is exactly the same as you in every way, that all people of every age and background have the same expectations, the same goals, the same ability to handle risk, and basicaly the exact same genetics. Rick Ferri

Rick,

That's not what I meant. I was trying to say that the behavioral issues should be more explicitly addressed.

Keith

That is exactly my point! The culture of age-based-asset-allocation does not address behavioral risk. Pushing young people into high stock allocations often results in less wealth rather than more wealth because doesn't address actual human behavior during market shocks.

Rick Ferri

[Alex Frakt]

The number one issue in determining whether a person can provide for their own retirement is their personal savings rate. The stuff we mostly talk about - asset class selection, fund selection, tax minimization - actually slots in at number three.

The issue we rarely talk about that slots between the two are the psychological - behavioral if you prefer - mistakes that investors make. I've only heard a fraction of the investing histories that Rick has, but nearly all of them are all variations on a theme of performance chasing until they get caught in a crash, followed by a long period of market avoidance.

Rick's approach to this is to try to season the investor by starting with a low equity allocation. But I'm not sure this solves the problem. It might keep them from bailing out to cash entirely, but if they are watching their portfolio they will still see certain asset classes outperforming or declining and are likely to have the usual response of piling on or selling out of the subclasses. My suggestion is to recommend the use of balanced funds since they control both overall portfolio volatility and mask the performance of the underlying asset classes. They also reduce the chance of mischief because the investor does not have to be concerned with rebalancing. I do share Rick's belief that the fund should contain a healthy dose of bonds even for the youngest investor to keep them calm during periods of market turmoil.

So what do I specifically recommend? Assuming this is all going into a tax advantaged account, a classic 60/40 balanced fund is an excellent choice. A constant 60/40 during the accumulation period has essentially the same expected returns as an age in bonds approach and there are some very good funds available. LifeStrategy Moderate Growth which contains 42% Total (US) Market, 18% Total International and 40% Total Bond in particular is a near ideal one fund lifetime holding. Wellington is a good choice for those who insist they want a more aggressive portfolio at 65/35 with a slight value tilt.

[bmelikia]

I have my entire Roth IRA at Vanguard in one of their Target Retirement accounts so this is very important for me to understand. . .

Rick,

I am curious to know. . .What is your thinking behind why a person age 30ish til 55ish should keep a steady 70% exposure to equities and not follow more of an "age in bonds" approach? Btw, I'm a big fan so thank you so much for posting something that gets me thinking.

Also, I know that the Vanguard Target Retirement funds are not perfect in this respect but the simplicity of having one fund is something that I like.

[stemikger]

Great Article Rick. I remember when I first started out at the ripe old age of 30 and I was 90% in equities and the minute stocks started to go down my inexperience caused me to sell high and go back in low.

I once read an article on Peter Bernstein entitled the 60/40 solution and it basically said this is the right allocation for most investors because you still get the up side of stocks with 60% but a more steady ride when stocks go down. I believe he said this allocation can be with a person for their entire lifetime.

Also Scott Burns recommends the Couch Potato Portfolio which tells investors to be 50/50 regardless of their age and rebalance once and year and stay at that allocation for the rest of their natural life.

And lastly Mr. Bogle has stated that the ultimate in simplicity is to buy the Vanguard Balanced Index fund and hold it for the long term. I’m not sure if he meant forever, but it did sound that way.

Do you think any of these approaches makes sense? Or has some validity.

Thanks Rick.

[Rick Ferri]

Rick, I am curious to know. . .What is your thinking behind why a person age 30ish til 55ish should keep a steady 70% exposure to equities and not follow more of an "age in bonds" approach?

At the heart of the issue is what investors who are low in experience and high in equity actually do when they meet their first bear market. If everyone young investor had high experience, high risk tolerance and lots of time, then a high allocation is correct for everyone. The fact is that young investors have low experience and don't know their tolerance for risk. The only thing that fits the model is time. To say to young people, "Don't worry about losing money because you have lot's of time" is factually correct, but behaviorally flawed. It's not going to change their behavior when they hit a bear market.

My idea is more philosophical rather than labeling precise exposures. Unfortunately, other age based allocation models have precise allocations at each age, so I provided an example as well. When should a young person increase equity? When they're ready to increase exposure because they have a better handle on risk. To what level should a person's equity climb? To the level they need but always it at or below their tolerance for risk. To what level should equity fall as retirement nears? To whatever their needs are anticipated to be in retirement.

I recently published another blog that has more data. See Perils of Crashing Through Risk Tolerance.

Rick Ferri

[adam1712]

As somebody who's been pretty close to 100% equities since 2004 (now working my way towards 80% as I'm now in my 30s), I don't see this as a strategy for me. Maybe for some young people it's good advice, but it definitely has it's challenges. Trying to convince somebody younger that even if the numbers say one thing that they don't have the experience to take as much risk is difficult without sounding condescending. Additionally, investors following this advice would be taking on a riskier AA later with bigger stakes with no prior experience.

I do think there's wisdom in giving people, including young people, options when choosing their AA. There's no reason somebody in their 20s has to have a stock-heavy AA. If they want to ease into it, great.

[Tonen]

I'd like to defend a simple glide path/ high initial equity percentage approach for young investors, provided it can be combined with "benign neglect".

My kids (early 20's) didn't bat an eye during the latest crash - their monies are tied up in superannuation (Australia, monies only accessable on age retirement), and they just look at the annual statement once a year. Annual rebalancing is automated. My biggest worry is that they have to raise themselves from this blissful torpor every 10 years or so to alter the equity/ bond mix - it'd be even easier again if we had access to target retirement options so that would happen automatically.

[Peter Foley]

I find myself in partial agreement with Rick - more so on the landing path than the take off. I agree that there is no substitute for experience when it comes to understanding one's risk tolerance. However, young investors usually don't have much skin in the game at that point in their lives so I would be inclined to get to a higher AA sooner - quite frankly for someone with less than $20,000 I think 10% in bonds is fine. I know Rick is trying to account for emotions, but I'm not sure an initial more conservative approach does that. It may make one overconfident later when more assets are at risk.

I do think the landing path analogy is good. Once one achieves one's goal there is good reason to take a more conservative approach.

[555]

"I find myself in partial agreement with Rick - more so on the landing path than the take off. I agree that there is no substitute for experience when it comes to understanding one's risk tolerance. However, young investors usually don't have much skin in the game at that point in their lives so I would be inclined to get to a higher AA sooner - quite frankly for someone with less than $20,000 I think 10% in bonds is fine. I know Rick is trying to account for emotions, but I'm not sure an initial more conservative approach does that. It may make one overconfident later when more assets are at risk.

I do think the landing path analogy is good. Once one achieves one's goal there is good reason to take a more conservative approach."

But the landing path feature is a totally standard feature of every glide path I've ever seen.

[HurdyGurdy]

Interesting proposal, it seems to be based on astute observations of investing behavior. Of course it stands contrary to models based on pure economic optimization (like proposals to be almost 100% in stock, until a few years before retirement).

Perhaps Vanguard (and similar companies) should replace their dry questionnaires about risk aversion by something like an engaging but realistic simulation game where the person will get to experience a lifetime (or many) of saving and investing. At the end, after analyzing the player behavior, the software would propose an optimal allocation strategy for that player.

[White Coat Investor]

I think there's way too much focus on getting the overall stock/bond asset allocation just right. I think that's kind of dumb. 80/20, 75/25, 70/30....it's pretty much all the same in a bear market or over the long term. I think it's more important to get in the ballpark and stick with it. I think it's unlikely that someone who would have stuck it out at 60/40 is going to bail at 70/30.

Take a look at the TR funds. TR 2010 is currently 43.3% stock. In 2008 it dropped 20.67%. TR 2015 is currently 55% stocks. It dropped 24.45% in 2008. I can't believe there are lots of people out there who would be okay with a 21% loss but bail with a 24% loss. Asset allocation is far less protective than education IMHO.

Likewise in the long run. Take a look at LS Growth (80% stocks). 7.56% returns over the last 18 years. LS Conservative Growth (40% stocks)? 7.17%. LS Income (20% stocks)? 6.89% over the last 18 years. It's almost as though asset allocation doesn't really matter at all.

I think we'd do a lot better getting investors to focus on saving enough and minimizing taxes and expenses than on getting their AA just right. It doesn't seem to matter nearly as much as most seem to think.

[joe8d]

EmergDoc wrote:

I think we'd do a lot better getting investors to focus on saving enough and minimizing taxes and expenses than on getting their AA just right. It doesn't seem to matter nearly as much as most seem to think.

[wade]

Rick,

Thanks, this is a compelling argument that looks to have lots of merit.

If you are looking to build an intellectual history of the idea, fellow Boglehead William Bernstein does discuss a similar idea in his recent book, The Ages of the Investors.

http://www.amazon.com/The-Ages-Investor ... +investors

It's a bit different from your suggestion, but here is how I summarized Bernstein's point in my Amazon review:

Despite the fact that young people can take much greater financial risk, Bernstein argues that young people are actually quite risk averse and should probably start with no more than 50% stocks. Then, they should gauge their reaction after experiencing their first big market drop to decide whether their appropriate stock allocation might be more or less than 50%.

[YDNAL]

At the heart of the issue is what investors who are low in experience and high in equity actually do when they meet their first bear market. If everyone young investor had high experience, high risk tolerance and lots of time, then a high allocation is correct for everyone. The fact is that young investors have low experience and don't know their tolerance for risk. The only thing that fits the model is time. To say to young people, "Don't worry about losing money because you have lot's of time" is factually correct, but behaviorally flawed. It's not going to change their behavior when they hit a bear market.

Sure, investors that lack experience and hold a high Equity allocation may react in detrimental fashion during large market drops.

• However, suggesting (forcing?) a young investor to hold moderate Equity - taking that at face value without specifics - doesn't preclude him/her from making a bad decision when they hit a bear market.
• Having said that, I can't accept grouping ALL young investors as having low levels of experience and group them to behave alike during different market conditions. Quite many 20-somethings right here in Bogleland are NOT mis-informed nor prone to do something stupid in the next bear market.
• Conversely, many old(er) and pressumably more experienced investors have made (and will make) bad decisions, despite holding low(er) Equity allocations, when IT hits the fan - and you know that yourself, Rick.

[Rick Ferri]

I can't accept grouping ALL young investors as having low levels of experience and group them to behave alike during different market conditions. Quite many 20-somethings right here in Bogleland are NOT mis-informed nor prone to do something stupid in the next bear market.

Yet, all age based asset-allocation models accept grouping ALL young investor has having high levels of risk tolerance. Which is better:

1) grouping every young investor as risk tolerant because of their age and risking high capitulation in a bear market.
2) grouping every young as moderate risk tolerant with the understanding that those who are more knowledgeable will make their own adjustment.

I see #2 as the right approach.

Rick Ferri

[YDNAL]

I can't accept grouping ALL young investors as having low levels of experience and group them to behave alike during different market conditions. Quite many 20-somethings right here in Bogleland are NOT mis-informed nor prone to do something stupid in the next bear market.

Yet, all age based asset-allocation models accept grouping ALL young investor has having high levels of risk tolerance. Which is better:

1) grouping every young investor as risk tolerant because of their age and risking high capitulation in a bear market.
2) grouping every young as moderate risk tolerant with the understanding that those who are more knowledgeable will make their own adjustment.

I see #2 as the right approach.

Rick Ferri

Rick, I don't see how you so easily paint with a broad "high capitulation" brush.

Inexperienced young investors - the ones who you assume (imply) are unable to "make their own adjustment" - are forced in #2 to lose significant ground over long periods of time when the Equity risk premium is expected to be their friend. This, unknowing whether capitulation would be an issue or not.

Point being that, regardless of age/experience, risk tolerance is quite often unknown until it smacks you in the face. Until then, a 50/50 vs. 80/20 split in Asset Allocation is not going to "save" anyone from bad decisions.

[Taylor Larimore]

I have my entire Roth IRA at Vanguard in one of their Target Retirement accounts so this is very important for me to understand.

bmelikia:

This is Morningstar's opinion of Vanguard's Target Funds:

Overall, while the target-date marketplace has become increasingly more complex, this series has proved that straightforward and cheap can lead to topnotch results.

Stay-the-course.

Best wishes.
Taylor

[Fallible]

Both articles pointing out flaws in the age-based models are excellent and based on plain common sense, especially regarding young people lacking experience to handle great risk. Next time I hear someone tell a young person to go heavy in stocks solely because of a long time horizon, I'll point them to these articles about gradually increasing equity holdings. Also liked your noting at the end that all models are just a "framework" in deciding how to invest and that "Each investor should adjust their allocation based on personal needs, circumstances, and their ability to handle risk."

[Rick Ferri]

Thanks all for the good feedback.

I wish to reiterate that under a default moderate risk model for young people that an educated and informed young investor who has high tolerance for risk will personally decide to take a higher allocation to stocks because they are educated and informed. The flight path approach to asset allocation changes nothing for these folks. It only changes the default allocation for young people who are not educated and informed and thus are at higher risk of capitulation in a bear market.

Just want to make this point clear.

Rick Ferri

[arcticpineapplecorp.]

Thanks all for the good feedback.

I wish to reiterate that under a default moderate risk model for young people that an educated and informed young investor who has high tolerance for risk will personally decide to take a higher allocation to stocks because they are educated and informed. The flight path approach to asset allocation changes nothing for these folks. It only changes the default allocation for young people who are not educated and informed and thus are at higher risk of capitulation in a bear market.

Just want to make this point clear.

Rick Ferri

Thank you Mr. Ferri for your articles. However, you state above that one should have a lower (default) allocation to stocks if they are not educated and informed. Why would anyone invest in anything that they are not informed or educated about? Are you recommending that people invest in things they are not informed/educated about? Shouldn't they be 0% in equities until they become more educated and informed about how the market operates? You assume that they would not bail on a less equity heavy portfolio (default) but people have sold for lesser losses (like $500...see below).

From your flight path article...
"Within three months my $3,000 investment had fallen to $2,500 and I panicked. To the broker’s credit, he tried to keep me invested. It didn’t help. I recall saying, “Just sell it!” and hung up the phone. Of course, the market went up shortly thereafter and didn’t stop for 17 years. My reaction in the early 1980s isn’t different from what many young investors experience in every bear market.

When a young person takes a high allocation to equity “because that’s what they’re told to do” and then sells during a bear market like I did, it messes them up for a long time. Not only did I feel angry about losing money, the experience created a lingering negative attitude about stocks in general. This kept me from investing properly during the roaring 1980s."

If you were in your twenties and sold at the loss of $500, then did you forget what your original goals were for why this money was invested? If it was for long term (20+ years) then why did you sell? I understand emotions override logic in people, but if people want to become successful investors they have to learn to overcome that. I congratulate you on having learned this valuable lesson at some point in your life (after this incident earlier on) so you could become a more successful investor and help others in the process.

Similarly, you mentioned some of your children (two I believe) bailed out in 2008. I've known people at work who did the same thing. One bailed in 2001, yet he continues to work 11 years later. Some of you might be thinking "he has to", but that's not true, he's still too young to retire. So if he didn't need the money for at least the next 11 years (he probably won't retire for another 10 years from now!) why did he sell? This seems self evident to me, but people seem to turn off their brains and not question this. They respond out of fear and act incorrectly instead of realizing "the loss occurred, I can't do anything about it now except wait it out and be thankful I invested in a broad based index fund which will gain over time, unlike Enron, Worldcom, and other individual stocks). When I regain my investment I can reduce my risk at THAT time (not now) since I wasn't aware I was more aggressive in my allocation than I want. In the meantime while I'm waiting for prices to return, I have an opportunity to buy more at lower prices!"

So, if young investors want to bail because they lost money, then they are not only more risk averse (then perhaps they were even aware), but they also don't have the fundamentals down about investing. This is not only a lack of experience as you suggest for young people, but perhaps more importantly, a lack of real understanding of how investing works and some of the key concepts involved (like buying, not selling, when prices fall, and realizing that broad based index funds should generally bounce back over time (how long is unknown but continuing to hold for at least another 5-7 years has generally resulted in favorable outcomes), etc.

These are some of the ideas that need to be understood before people put money in equities. Experience is an important teacher, but the lessons need to be understood first and then experienced after, in order to reinforce what was supposed to have been learned.

[freebeer]

Thanks all for the good feedback.

I wish to reiterate that under a default moderate risk model for young people that an educated and informed young investor who has high tolerance for risk will personally decide to take a higher allocation to stocks because they are educated and informed. The flight path approach to asset allocation changes nothing for these folks. It only changes the default allocation for young people who are not educated and informed and thus are at higher risk of capitulation in a bear market.

Just want to make this point clear.

Rick Ferri

Rick, what still seems unclear is that you are stating as fact in the original article that the lower default allocation to stocks for young people "increases the probability that they will stay the course in a turbulent market". You reiterate this here as such people who are "young people who are not educated and informed... are at higher risk of capitulation in a bear market". Either there is some data to back up this contention about not staying the course, that for some reason wasn't referenced, or it would seem that your article should have caveated it as just being a hypothesis of yours. In which case there is no reason to conclude that the flight path approach would yield superior results, since the glide down at the other end is rather conventional. The piece of data in your second article that indicates those born since 1977 have lower propensity to take risk is only suggestive, it doesn't speak directly to whether once they have decided on an given allocation they would or would not stay the course having taken a given amount of risk in the first place. Maybe yes, maybe no. I don't criticize your proposal only suggesting that there's a difference between a hypothesis and a conclusion and "younger = increased-risk-of-capitulation" seems like the former to me based on what you've written so far.

[Rick Ferri]

Thank you Mr. Ferri for your articles. However, you state above that one should have a lower (default) allocation to stocks if they are not educated and informed.

In our culture, if you're a young investor who asks a general question to people you work with, or your relatives, or on a forum like this, the majority of responses you will get will be "Buy stocks. Over the long-term stocks provide the best returns, so buy stock and hold on." It is a return based answer.

If you were in your twenties and sold at the loss of $500, then did you forget what your original goals were for why this money was invested?

You bet I did. The emotion I felt by losing money was overpowering. I didn't know that the the losses were temporary. All I saw was my portfolio going down. I figured if I didn't sell that I'd eventually lose everything. So, it was better to sell sooner than later. I was a business major in college, BTW. It didn't help.

people seem to turn off their brains and not question this. They respond out of fear and act incorrectly instead of realizing "the loss occurred but I can't do anything about it now except wait it out.

That is correct. Rational thinking goes out the window until you have experienced a few bear markets, or you have someone there through the whole experience, holding your hand, keeping you in the game.

Experience is an important teacher, but the lessons need to be understood first and then experienced after, in order to reinforce what was supposed to have been learned.

Yes. Unfortunately, most young investors do not have good mentors so they don't know what to do wor what to expect. That's why a lower allocation to equity as a starting point makes more sense for most young people.

Rick Ferri

[White Coat Investor]

I don't think telling a young investor to gradually increase stocks as they become more comfortable with them is a recipe for success. They are likely to become "comfortable" after a big run-up, exactly the wrong time to increase an allocation to them. Far better to say "Pick a number, any number, and stick with it."