Nobel laureate economist Eugene Fama was once asked to define the ideal portfolio. He looked bemused for a moment before replying that there was an infinite continuum of possibilities. Why? Because every person is different.
So much of the media’s commentary about investment presumes an ‘average’ investor, when in fact no such person exists. We all have different tastes and preferences, different tolerances for risk, different time horizons and different goals in life.
That means it pays to be wary when someone tries to sell you what appears to be an off-the-rack solution to a problem that requires something more tailor-made. The portfolio may ‘fit’ you at a superficial level but may be all wrong in other ways.
This isn’t to say there aren’t some general rules of thumb in putting together an asset allocation for each individual but there are often mitigating factors for different people. And that’s where the insight of an expert adviser can be critical.
Start with the goal
A good starting point when designing a portfolio is to identify the goal. For instance, a 25-year-old saving for retirement 40 years away should be prepared to take on more growth exposure than a 60-year-old due to leave the workforce in five years.
But if that same 25-year-old has little tolerance for risk or big losses in any one year, an adviser may decide to pare back the growth allocation of their portfolio from, say, 90% to 80% to reduce the bumps in the road along the way.
Likewise, if the 25-year-old’s primary goal is not a distant retirement, but saving for a home deposit in five years, their portfolio may be far more conservative and tilted toward fixed income than for a much longer timeframe.
The general rule is you will hold a lower proportion of your portfolio in stocks as you age, but there can be wide variations within that.
And much of that variation can be driven by individual factors.
Consider the individual
Even two people about the same age can have significantly different asset allocations.
For instance, a 30-year-old stockbroker with income leveraged to the performance of the stock market, may want a lower exposure to equities than a 30-year-old university academic with tenure.
A 45-year-old with several highly-geared investment properties may want to be more conservative in their stock and bond portfolio than someone of the same age who owns their own home mortgage-free.
A 35-year-old freelance artist, whose work income is intermittent, may be a little more wary of risk than someone of the same age in a secure corporate role with a regular salary and insurance benefits.
And even once all these factors are considered, there is always the possibility of an evolution in circumstances and preferences.
Consider the lifecycle
The one constant in our lives is change. We change careers, we marry and start families, we divorce, we look after ageing parents, we emigrate. People’s circumstances change constantly across their lifetimes and their portfolios need to take account of that.
A young, ambitious, highly-paid lawyer in their 20s and 30s may undergo a change of heart in their 40s and become a social worker. While their life satisfaction may increase, their earnings will probably be significantly less.
A two-income couple in their 20s with no dependants will have significantly different needs than the same couple two decades later, divorced, mortgaged and with three children to support.
A single woman in her 40s on a low income in rented accommodation may a decade later have inherited a large home from her late mother and find that her portfolio requires significant rebalancing.
Nothing stays the same for long and investment plans need to consider that. Again, this is the benefit of having an adviser who understands your individual circumstances inside out and knows your preferences and works with them over time.
Beware of the cookie-cutter
The take-away from all this is that investment solutions need to be flexible. People, even of the same age, are different. Portfolios need to take account of income, life circumstances, preferences and goals.
How you distribute your investments across different assets can depend on your time horizon, your appetite for risk and the nature of your broader portfolio, including your ‘human capital’, or how you make your living.
Finally, changing circumstances and needs across time mean you need to constantly re-evaluate your portfolio to ensure it is still consistent with your goals.
For all these reasons, while recognising the need to consider broad rules of thumb, there can be no one-size fits all solution.
People are infinitely different. So are investment solutions. Matching one to the other is what a good adviser does.
The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.
This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.
Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.