One can predict with some accuracy stock market returns over the next 20 years by looking at market valuations. History indicates that 10 – 20 year time periods of poor market performance come after market valuations have been extremely high. On the other hand, when stock market valuations are low the next 10 -20 years have higher than average rates of return.
Related: Quantitative vs. Qualitative Approach to Value Investing
While it is fruitless to try and time the market in the short term, long term timing is nothing more than buying investments at attractive prices and avoiding owning overpriced assets.
Therefore stock market valuations should be a more important consideration than asset allocation by age. Why would a 30 year old investor want to lose 50% of their portfolio by investing in overpriced assets any more than a 50 year old investor would want to lose 50% of their portfolio?
Take into consideration that a 30 year old investor is potentially losing more money than the 50 year old because he has lost principal that would have compounded for many years.
Yes, the younger investor has more years to make it back, but the fact remains neither scenario is good. Valuation, instead of age, should be the major consideration in determining your asset allocation.
Does Asset Allocation By Age Make ANY Sense?
There is no doubt some consideration should be given to age in asset allocation, particularly those over the age of 70. But I think the evidence is strong that a prescribed rule of thumb does not make sense.
Simplicity is always seductive but not always effective. Investors who desire to take short cuts will most likely wind up getting hurt by rules of thumb that don’t apply to current market conditions, don’t take into account valuations, and certainly don’t account for an investor’s personal situation.
Asset allocation by age is a flawed rule of thumb. Increasing lifespans, expensive bonds and stocks, and increased asset correlation should cause investors to be skeptical of this rule of thumb. Capital preservation should be the primary focus of every investor. Investors of every age should make valuation the primary determinant of their asset allocation.
This article has been republished with permission from Arbor Investment Planner.