Whenever I get the chance to speak with a lot of young people about investing, I always find out they are holding too much cash either in their savings account or in treasury bills. A 2014 UBS survey, reports that millennials held only 28% of their portfolio in stocks and the rest in cash and bonds.
This goes against the grain of conventional wisdom that an individual should allocate more to stocks when they are younger, as this allows their portfolio the luxury of time to recover if it were to suffer from a market downturn. Also, since the stock market has a much better long-term performance record, the portfolio has the chance to grow faster.
Given the understanding that asset allocation is the key determinant of portfolio returns, the dilemma is figuring out how much risk to take.
In determining the appropriate asset allocation, a commonly cited rule of thumb, that has helped simplify the asset allocation question is to allocate ‘100 minus your age’ into stocks. So, for a 30-year-old, 70% of the portfolio should be equities and the rest in fixed income and other relatively safe assets. If you are 70year old, then you should have 30% in stocks and 70% in fixed income.
Pretty straightforward, right? Perhaps not. After all, age is not the only factor in determining asset allocation. Factors such as – yield environment, age at retirement, life expectancy, assets needed to sustain one’s lifestyle in retirement etc., would also be key.
Given its shortcomings, some have modified the rule to ‘110 minus your age’ – or even ‘120 minus your age’, for those with a higher tolerance for risk or whose situation would require allocation to equities.
However, with the yield environment quite high in Nigeria a ‘100 minus your age’ is a good ‘starter portfolio’ for the average first time investor