Many of you still think that you should de-risk your portfolios as you get older by holding fewer equities. You should ditch this idea, because for many of us it is plain wrong.
One reason it is claimed that older people should own fewer equities is that they have fewer years ahead of them in which to recoup any stock market losses.
But this is false, and not just because many older people plan on leaving shares to their children and so do have long time horizons.
It’s also false because it is not the mere passage of time that erases losses but rather the market’s ability to bounce back. And in the past, this ability has been predicted simply by the dividend yield. Since 1985 anybody who had bought when the yield on the All-Share index was over 4.5 per cent would have made an average total real return in the following five years of over 75 per cent. But they would have lost an average of 14.5 per cent if they had bought when the yield was under 2.5 per cent.
The rule “buy when yields are high” has worked better than buying just because you were the right age. If you are in equities for the long-term, you’ll be in when valuations are high and when equities subsequently lose you money. It’s better to be in shares for a short time at the right time than for the long term.
You might object here, reasonably, that the future might not resemble the past and that perhaps valuations will no longer predict returns.
Even if this is the case, though, it doesn’t follow that equities are better for younger people. If shares aren’t going to rise in the first five years after they have been cheap, why should they rise thereafter?
In fact, history offers several examples of older shorter-term investors doing better than young long-term ones. The old man who bought Russian equities in 1907 and died before 1917 would have seen better returns than the younger man who held on for the long run. Ditto the Japanese investor who bought in the 1980s before the Nikkei began its long slump.
We can’t rule out a repeat of this. It’s quite possible that, after a post-Covid bounce, western economies will revert to their pre-pandemic pattern of weak growth. That means greater risk of earnings disappointments and crises. That’s an environment which favours shorter-term investors. The young Japanese investor who had bought the Nikkei 225 at 36,000 in 1989 has grown old waiting in vain to recoup his money. There’s a danger of the same thing happening here.
There is, however, one good reason why some of us should cut our equity holdings as we age.
It’s that while we are working we have a way of spreading equity risk. If the market falls we can top up our wealth by working longer or by saving more of our salary. Our human capital then diversifies our equity holdings. But if you are in retirement (or close to it) you don’t have this diversifier, so shares are riskier for you. Which means you should hold less of them.
This is certainly true for some people. But not all. If you work in banking or a cyclical industry like construction you risk losing your job or bonus when equities do badly. For you, shares compound the risks you already face. Which means it’s safer to own them after you retire.
This is especially the case if you retire on a big final salary pension. This gives you, in effect, a huge bond-like asset. That’s safer than many people’s jobs. And this cushion enables you to take lots of equity risk.
For some people, therefore, it makes sense to actually own more equities as you age, not fewer.
We should, therefore, forget talk that equities are less suitable for us as we age. How much of your wealth you put into shares depends upon many things, such as valuations, your appetite for risk and the other risks you face. How many miles you have on the clock is not one of these things. In investing – if not alas in life – age doesn’t matter.
But there’s another point here. Nothing I’ve said here is new or original. It was all said a quarter of a century ago by Ravi Jagannathan and Narayana Kocherlakota, two distinguished US economists. The fact that people still believe the myth today shows that bad financial advice can live on long after it has been debunked. Which poses the question: what other old ideas might we be clinging onto after they have been refuted?
