For those of you who have never heard of Lifecycle Investing (not to be confused with target-date investing), go to your local library or Amazon.com and pick up a copy of Lifecycle Investing right now. It not only introduces the idea of lowering risk or increasing returns, it lays out a simple plan to diversify your investments by completely changing the way you think about investing.
What is Lifecycle Investing?
When you are young, you have a relatively small amount of money invested. Let’s pretend you are 25 years old and have $50,000 to invest. Even at 100% in stocks, that’s just $50,000 invested in stocks, a drop in the bucket compared to what you’ll have invested later in life. Compare that to when you are 50 years old and have $500,000 invested. At just 60% in stocks, that’s still $300,000 invested in stocks, 6 times what you had at age 25. Lifecycle investing is the idea that we should balance our investments over time and ideally, we’d have the same amount invested at every year. It would be better to have $100,000 in stocks when you are young and only $200,000 invested when you are older so that you have more similar amount of money at risk.
Imagine you are in your late 50s, you are nearing retirement, and the market crashes, wiping away a large portion of your net worth because you still have so much invested in stocks. With lifecycle investing, you transfer some of that wealth to earlier in your life to reduce your overall risk. You leverage your investments to gain more exposure to the market now so that you can shield yourself from too much risk later.
The idea of lifecycle investing is that you can leverage your money (buying options is one way of doing this) to even out the risk over time. So while you are young, you can invest 200% in stocks, so that by the time you reach your 50s and 60s, you can bring that stock percentage down to 30%.
The figure below compares the lifecycle investing strategy to the “birthday rule” strategy, that the percentage of your money invested in stocks should be equal to 110 minus your age (if you are 30 years old, about 80% of your investments are in stock). It shows that with the lifecycle strategy, you start with 200% of your investments in stocks for about 10 years, and then quickly reduce that rate so that by the time you hit about 40 years old, you’re taking less risk than the birthday rule strategy.
How Can Lifecycle Investing Help?
Some of the most basic investing advice is to diversify. If you are like most personal finance bloggers, you buy index funds so that you own a little bit of everything without being too risky.
Lifecycle investing is the idea that you can diversify by spreading the risk over time instead of just over different types of investments. It’s possible to earn the same returns with lower risk, or better yet, (up to 50%) higher return with the same mathematical risk.
Sounds Like A Trap. 200% In Stocks Is Riskier Than 100% In Stocks
While it may seem that investing 200% in stocks is riskier than just 100%, the easy to understand charts and graphs show that (and the authors have made all data available on their website) by starting off with a higher percentage of money in stocks, it actually reduces risk overall and lets you take advantage of your younger years when you’re still building up your savings. Most people invest most of their money over a 20-30 year period. With lifecycle investing, you’re able to spread that out to include your younger years as well. After tens of thousands of simulations, lifecycle investing comes out ahead in just about every situation. If only people had taken advantage of this knowledge sooner!
Why You Should Read The Book Now
The great thing about lifecycle investing is that you don’t need to be at the beginning of your career to take advantage. The authors have simple formulas for how much you should invest in stocks at your phase of life and risk profile. It’s never too late to start. I highly encourage you to check out the book and find out if this is the right strategy for you. I read the book, discussed it with friends and family for awhile, and then jumped in to a certain extent. I’ll be following up with related posts on lifecycle investing like exactly how to take advantage and some other related commentary.
Have you heard of lifecycle investing? What can I do to convince you that this is the best way to invest over the long-term?