investing

How to invest across your life cycle

Richard Serlin, University of ArizonaHow should you invest? The answer differs somewhat depending on your age, of course.

However, a surprising amount of good investment guidance applies equally to everyone, from young people to retirees, according to Richard Serlin, adjunct professor of personal finance at the University of Arizona's John and Doris Norton School of Family and Consumer Sciences in Tucson.

In part one of a two-part interview, Serlin discusses the things all investors should keep in mind on their journey to financial security.

What's the ideal portfolio strategy for a young investor? How much should be allocated to equities versus other asset classes?

Good advice for most young people is that they should divide their savings into short-term and long-term, with long-term money being money that they want to put away for 10 to 50-plus years. Short-term money is really money that you think there's a very good chance you'll need within 10 years for something very important.

The distinction between short-term and long-term money is important because you want to be careful not to put too much money into short-term investment. It pays a lot lower return on average. The average historical return on a well-diversified stock portfolio -- the go-to long-term investment -- is about 7 percent in real terms, inflation-adjusted. By contrast, short-term bonds -- the go-to short term investment -- today pay about zero, or negative in real terms.

I'm a believer in stocks for the long run. Over 200 years, stocks have averaged a real, inflation-adjusted return of almost 7 percent. This may not seem like much, but with the immense power of compound return over long periods, it is.

So, for money that you are reasonably sure you won't need for 10 to 50-plus years, I recommend a well-diversified stock portfolio, with the emphasis on well-diversified. Don't put all your eggs in one basket. Even the biggest, most stable, single stocks can go bankrupt, or tank.

Now, I have talked about the wonders of stocks for your long-term money, but there is risk. The higher the percentage of your money in stocks, the higher the risk. Thus, for most people, even young people, 100 percent of your investment shouldn't be in stocks.

So, what else? Usually, you really want to pay any debt down to zero, especially high-interest debt.

Paying your mortgage off faster, getting to zero mortgage as quickly as possible, is fantastic for financial security in today's far more financially dangerous world. In general, a key goal is to get your "must-haves" as low as possible. That way, if there's a job loss, illness, etc., you can weather the storm without quickly destroying your savings and going into ruin.

What about your short-term money? A good choice is CDs. They are insured by the federal government up to $250,000 per person, per bank, but they tend to pay more interest than comparable government bonds.

You can go longer term, and protect yourself against inflation, with TIPS (Treasury inflation-protected securities), but the market for these is shallow, so that lately the interest is ultra low -- even negative.

And to really play it safe, for money you might need very soon, there's a money market fund, which invests in very safe bonds maturing in a matter of months. Or, just a savings account at your bank, which is insured by the government up to $250,000.

What's the ideal portfolio strategy for a middle-aged investor?

Most of what I've said for young investors above applies here, too. Your horizons are still usually quite long in middle age, especially if some of your money is to help your children throughout their lives in a very risky, dangerous America today that may only get more (risky and dangerous) in coming decades.

And as you get older, it becomes more and more valuable and "high return" to invest in your own health. Good health greatly improves job performance, security and career longevity. Poor health can devastate it.

In middle age especially, I'd like to stress the importance of not overspending on your home. This is crucial for financial security and wealth accumulation.

How about the investor who is approaching retirement?

Again, like middle age and youth, it's a matter of what portion of your money you consider long-term, and what portion you consider short-term.

An important issue that starts to come up here is when to start taking Social Security. The general rule is that it's normally a tremendous deal to wait as long as possible, up to age 70, when the benefit maxes out.

If, sadly, your health is very bad, and you think it is unlikely that you will live until 70, or much past, then you should collect early – unless you have a healthy spouse who will be taking over your benefit. Then, you still want to grow that benefit as long as possible.

Many people at this age think, "My savings are low, but I'll just keep working until I'm 70 or beyond." I'm sorry, but that's usually wishful thinking. People underestimate how much the average person's health and endurance deteriorates even by 65, let alone 70 or beyond. Moreover, skills get antiquated, and job discrimination at that age is fearsome.

And what about the investor who is in retirement? Is there a rule of thumb that should be followed?

Much of what I've said in the questions above applies for investors in retirement.

When you're this old, there's no completely escaping substantial risk. Even if you're a billionaire, you could still, probably with significant probability, die of a heart attack or cancer before you see the 2020s.

But if you do what I just mentioned -- with the no debt, no mortgage, reasonably low "must haves," and waiting until 70 to collect Social Security -- then unless you have unusually high standards, financially, you'll still always be able to live at least not bad, at least if you can still take care of yourself.

I'll also add that the time horizons for a lot of seniors' money is longer than people think. A 65-year-old couple will probably have one spouse live at least 25 more years, so there should usually be significant stock investment. Moreover, if you want to leave money to your children and grandchildren, their horizon is decades.

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