Make way for the young conservatives.
No, they’re not a political club – more like an investing movement. Whereas some young people engage in all kinds of risky behaviour, many are choosing the safe approach to investing. Surveys of young adults have shown this to be the case since the stock market plunge of 2008–09 and it begs a question: Why?
Young investors – let’s define them as people in their 20s and early 30s – should embrace risk. Imagine you’re 28 and investing through a registered retirement savings plan. You can afford to let stocks or equity funds dominate your portfolio because four decades could easily go by until you need the money. Worried about a stock market decline? Relax – history tells us that even a 10- or 20-year holding period is long enough for the stock market to deliver on its potential for better returns than you get investing safely. The S&P/TSX composite total return index (share price gains plus dividends) made 7.8% annually for the decade to July 31, and 9.1% per year for the past 20 years. Those numbers include the 33% plunge the index endured in 2008.
Some young bucks might read this as an invitation to invest only in stocks and forget bonds or cash. Wrong. Unless you’re unflappable in a stock market plunge, and almost no one is, then you need the stability provided by bonds and cash. When money flies out of the stock markets, it goes to bonds. Even a token 10% or 20% weighting in bonds will help take the edge off a stock market plunge. Add a 5% weighting in cash and you’ve got even more stability. Note: Cash refers to money market funds, Treasury bills, high-interest savings accounts and other virtually risk-free parking spots for money in your investment account.
There’s a longstanding rule for figuring out how much of your portfolio to put in stocks – just subtract your age from 100. Thus, a 25-year-old would have a portfolio 75% weighted to stocks. Today, there are some who believe this calculation needs to be tweaked to reflect the fact that people are living longer and thus requiring more in savings. They suggest you set your weighting in stocks on the difference between 110 or 120 and your age.
This is just a guideline, mind you. I say you can afford to be aggressive as a young investor, but my argument is an intellectual one. You may not emotionally be able to live with the ups and downs of a high weighting to stocks and that’s fine. Just recognize that if you invest safely, you will very likely have a lower long-term rate of return. This, in turn, suggests you will have to make do with less in retirement, or contribute more to your RRSP.
In my next blog post, we’ll look at how you should adjust the risk level of your portfolio down as you get older.