(This column has been corrected to fix spelling of co-author’s name to Straehl in seventh paragraph)
By James Saft
A younger person, with more time to out-earn their mistakes, can take on more equity risk than an older one, who has less potential earnings in front of her, and less time to overcome career setbacks such as layoffs. At the same time housing, financial and pension wealth rises, offsetting some of the risk.
VOLATILE REAL ESTATE AND JOB MARKETS
The paper found that a 25-year-old’s optimal allocation is 61 percent equities, a figure that falls to 48 percent at 45 and just 26 percent at 65.
The total wealth approach to allocation led to an average annual increase in risk-adjusted outperformance of 30 basis points annually across the 1,000 scenarios studied, according to the study.
Housing makes up an important part of most people’s wealth: a fifth of the total wealth of the average 60-year-old. Housing too, as we learned in the last decade, can be a volatile asset, especially given that it is usually debt-financed, magnifying gains and losses.
The study looked at optimal allocations for home owners in 10 major cities and found, unsurprisingly, that those who own real estate in volatile places like Las Vegas or Miami should hold more cash and more bonds.
People don’t just have jobs, they have jobs in industries, and for good or ill, their future wage earning ability is tied to the fortunes of that industry. The findings here too aren’t surprising: work for the government and you can probably take on more investment risk than if you work in hospitality or lodging.
While many advisors may take this into account, and some individuals surely do, it is far from standard practice, and probably should be.
Going beyond this, it makes sense for workers in industries to vary their allocations between equity sectors in order to diversify their risks. Work in manufacturing? You probably should have some extra commodities exposure as when raw materials go up in price your industry does poorly. Work in mining? Don’t own mining stocks.
Much of this is what a good financial advisor should already be doing – getting a feel for the totality of a client’s position and making the needed adjustments.
It probably won’t be too long before robo-advisors begin to offer adjustments based on these factors, even down to industry risk profiles.
Human advisors would do well to get a head start.
(At the time of publication James Saft did not own any directinvestments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund)
(Editing by James Dalgleish)
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