The percentage of cash in your investment portfolio should equal your age. So if you are aged thirty-three, 33% of your liquid assets should be in cash and if you are aged 75, then 75% of your liquid assets should be in cash deposits. It follows then that by the time you reach 100, all your money will be in cash deposits. You can take the equity in your residential property out of the equation, but you should include the equity in any investment property or holiday home.
The logic behind this is twofold:
a) At younger ages the volatility inherent in equity-based investments is acceptable assuming that the intention is long-term savings. In fact, if you invest monthly into equity-based savings plans such as Equity ISAS volatility works in your favor due to the effects of pound cost averaging. Equity-based investments will also, if chosen carefully, provide a real return above inflation, whilst deposit interest will struggle to match inflation. As we age and become more reliant on pensions and savings to provide income, volatility becomes less acceptable.
b) From a pure peace of mind point of view large falls in the value of investments are emotionally difficult to deal with for older people. Equity values can halve in a reasonably short period of time and whilst their values may return in say 7 years, that uncertainty isn’t what most people envisage their retirement being about.
A couple of examples of poor planning might help here:
I dealt with one gentleman who came to see me at the age of 75, ten years after retiring. At retirement, he had put all of his money into various deposit accounts. I have to say he’d done a great job of spreading his money around and taking advantage of various offers. At the time of retirement, he was getting around 12% interest on his capital. He was using the interest to supplement his retirement income. The problem, he told me was that interest rates had fallen to half of what they were when he retired and therefore he was beginning to eat into his capital in order to maintain his income. He wanted to now invest in equities essentially to get a higher income and had already invested £20,000 in an insurance bond via the TSB.
My opinion was that the bond investment wasn’t a good idea as looking at the charging structure and performance history of the managed fund, he could probably expect a 7% return on average. A potential extra 1% income with a large downside to capital obviously wasn’t worth the risk. Further, I couldn’t find any reason to make a bond investment instead of a PEP or Unit Trust even. Too late, the deal had been done. If however, he’d followed the age rule he would have had 35% of his money in equities at retirement. Any reasonably managed fund would have doubled his money over that ten-year period and he could have progressively withdrawn capital to have reached a 25% equity investment split at his current age.
Another very common scenario is people who have benefited from their company share save scheme who often hold substantial funds in just one share. I’ve met a number of people who’ve been in this position and have done very well over the years from it. However, at (often early) retirement they are unable to let go and so have a very skewed investment portfolio with up to 90% of their money in equities. Add to that the obvious danger of being invested in just one company and their position is precarious, to say the least. Capital Gains Tax has to be taken into consideration of course when selling equities, as does the level of stock markets.