Age-Based Asset Allocation: A “Glide Path” For Young Investors
December, 15 2015 | Prashant Mehta
Recently Invessence participated in the ETF.com study of robo-advisors. One of the study objectives was to come up with a hypothetical recommendation for a 13-year-old boy about which robo-advisor to use. To address this, we put together an initial investment portfolio for him and then determined how his asset allocation would change over the next 50 years.We created the “glide path” graphs and figures shown below to illustrate the portfolio asset allocation changes over time. These tools are readily available on our website for use by Invessence’s current and prospective clients.
Our asset allocation process is based on the particular client’s risk level and consists of two stages. In the first stage, we determine an optimal asset allocation among major asset classes, i.e., Cash, Bonds, Equities, and Commodities. In the second stage, we determine allocation to sub-classes within Bond and Equity asset classes.
Figure 1 shows the glide path for a teenager’s portfolio for the four major asset classes. Cash and Commodities exposures remain fairly constant over the next 40 years at 1% and 3% respectively and then decline to zero over the last 10 years. Given the long investment horizon, the initial portfolio is almost entirely invested in Equities and does not have any exposure to Fixed Income (Bonds and Preferred Stock). Starting with Year 10 we introduce Bonds and begin to reduce Equity exposure. The rate of increase in Bond / reduction in Equity exposure remains fairly constant over the next 20 years (until Year 30) and then accelerates over the last 20 years.
Figure 2 shows the composition of the Bond portion of a teenager’s portfolio over time, while Figure 3 details the Equity portion. During the earlier years of higher risk tolerance, both the Bond and Equity portions have exposure to higher expected return / higher-risk sub-classes, which decline over time. Thus, in the Bond portion, exposures to High Yield, Emerging Markets Debt, and Preferred Stocks decline over time to reduce credit risk, while in the US portion of the portfolio, the duration risk is reduced by shifting the allocation from the longer maturity bonds to the shorter ones.
Similarly, in the Equity portion, exposures in the US Small Cap and Emerging Markets decline over time, while the exposure to the US Large Cap increases.
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. This website and information are provided for informational purposes only. Do not try to implement any strategy discussed on this website on your own as they are designed to be implemented by Invessence for enrolled clients only. All securities involve risk and may result in loss.