The wonderful thing about youth is how limitless it feels. Unaware and uncompromised by the realities of risk, we are more daring when we are young.
We also fall down a lot, get our knees scraped and occasionally take a real tumble. And that’s okay — at least within the limits set by the adults in our lives.
Then, quite naturally, we get older and a bit wiser. A broken arm at 14 is a distant memory, while at 40 it’s a real hassle and at 80 a potentially serious health problem.
Investing when you are young is much the same. Young people rarely have a lot of money on the line, since they are just starting out. An all-stock portfolio to them feels less like risk and more like optimism.
If you are lucky, that kind of feel-good investing can last quite a while, maybe years. Then stocks take a tumble, as they do from time to time. If it happens when you are in your 20s or 30s, you might not even notice.
A big drop in the stock market in your 40s is another matter. By then, you are more cognizant of the problems with taking on too much risk. It’s very hard to overcome a serious decline in your account balance, and virtually impossible if you panic and sell at the market low.
When you’re retired? Forget it. Lose money in retirement and it’s gone. Your opportunity to compound is nil and any investment that might quadruple your money in short order might just as easily wipe you out entirely.
Nevertheless, you can invest like a kid again, free from fear. The way forward is to carefully measure your own capacity to take on risk.
Early in your investing years a portfolio that’s heavier with stocks makes a lot of sense. You will be putting money in along the way, so a market drop can be a chance to average in at a lower cost.
When you hit your stride in middle age, you still need stocks. Inflation will not be kind to your nest egg over the long term, so it’s important to keep a good portion of your money in equities for their inflation-fighting return.
Reducing the volatility of your portfolio is the key move here. By owning bonds, real estate and other investments you can manage the ups and downs of the market more easily. If stocks accelerate, rebalance gains back to bonds and real estate.
Likewise, if stocks fall, allocate incoming bond interest and dividends to stocks while they are cheap.
Finally, in your retirement years, keep at least some of your money in stocks to offset inflation. It need not be much, and definitely shouldn’t be so much that a market crash means starting over.
That way, even at 70, 80 or beyond, you can invest worry-free, like a kid again. You’ll be much less concerned about what could go wrong, and that’s ultimately what financial freedom is all about.