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What's age got to do with portfolio construction?

In general, younger investors could choose to take on more investment risk because they have more time to recover in the event of a market downturn whereas older investors may want to move money out of riskier assets, like shares, and into safer options, like bonds and money market funds as they approach or experience retirement.

That being said, Vanguard's study of 5 million client households in the U.S. last year revealed some fascinating investment behaviour, particularly the differences in asset allocation across and within generations.

Not all millennials strived for growth and not all boomers reduced risk

What was most striking in the study wasn't age-related differences in equity exposure, but rather, the wide range of risk-taking within any given age group.

While millennials had the highest median allocation to equities, at least a quarter of the cohort adopted far more conservative portfolios, meaning there was a high level of risk aversion amongst younger investors despite their age and available investment timeframe.

Conversely, among older investors, the allocation to equities remained quite high despite approaching or already being in retirement. You can read more about the findings here.

So, is risk good for younger investors but bad for older generations?

Yes and no.

For older investors, you don't need a completely risk-free portfolio (in fact, there's no such thing) to be successful. While your investment timeframe and stage of life may suggest it's prudent to reduce risk, it's also important to keep in mind that lower-risk investments tend to have more exposure to inflation risk, which is the possibility that rising prices could diminish the value of your investment returns. So, it's more about making the right adjustments as you approach your goals rather than not investing in equities or avoiding risk altogether.

For younger investors, just because your age may mean you have a longer investment time frame, it doesn't mean it should override your individual goals or attitudes towards risk and uncertainty. Having a broadly diversified portfolio that includes fixed income or cash is still necessary for younger investors. It's just a matter of how much of your portfolio do you allocate towards each asset (including equities) so that you can offset inflation and achieve growth while still be comfortable with the risk you're taking.

Constructing a portfolio using readymade, diversified funds

Portfolio construction can be a daunting task if you are new to investing and not sure where to start. Similarly, it can be difficult to know when or how to adjust your portfolio as you age or as your goals and attitudes towards risk change.

Diversified ETFs and managed funds can be helpful options to consider when that's the case as they've been constructed according to different investor profiles, taking into account investment horizons, risk tolerances and investment goals.

For example, investors who are more risk averse and prefer capital protection over capital growth may find a conservative diversified fund with a lower allocation to equities and a higher allocation to income assets most suitable.

Equally, investors who prefer a 50/50 allocation to equities and fixed income may opt for the balanced fund, while growth investors with a high-risk tolerance and preference for equities can opt for the growth or high-growth funds.

The most important aspect of diversified funds is that no matter which fund is selected, investors can still maintain an appropriate level of diversification across and within asset classes aligned to their attitudes towards risk.

In essence, each diversified fund is a ready-made portfolio that can be used as a complete solution for investors who are just getting started, or combined with other select investments in a here.

Vanguard

29 Mar, 2022

vanguard.com.au