On this week’s episode of Your Questions, Answered Tony Roberts and Brian Leitner discuss maintaining the desired equity exposure, and answer the following question:

“How much equity exposure should you have in your investment portfolio?”

Do you have questions you’d like answered? Email them to [email protected], and we’ll provide answers.

Transcript:

Brian Leitner: You have questions. We have answers back with another quick clip. We had a question that came in, this individual is trying to determine how much equity exposure they should have in their overall portfolio. And there’s a rule of thumb out there that says, Hey, to make that determination, you take 100 and subtract your age and whatever’s left over, should be the amount of equity exposure you have in your portfolio. What are some of your thoughts around that, that rule of thumb or that approach? 

Tony Roberts: Yeah. Brian, thank you. I like this question. I think these rules of thumb exist and last because they simplify an important concept. And in this case, that concept is that, as your investment time horizon shrinks, you have less time to recover from transient price volatility. So, as this rule would imply as somebody gets older as their time horizon begins to narrow, they should have an ever-decreasing allocation to equity in their portfolio, because equities are higher volatility, higher risk investments. So, I think it’s a good rule in general, but I think the, I think it introduces a couple of challenges. And one of those would be, we’re living longer today. You know, on average, people are living a few years longer than they did just a couple of decades ago. So, such a rigid model like this could leave a portfolio with too high an allocation to fixed income where it’s not achieving the rates of growth that are necessary to sustain the client over a longer horizon. The other consideration I think that would apply is that we’ve seen about three decades now of declining interest rates, lower rates of return on fixed assets. So, if somebody in retirement is looking to generate a stream of income to meet expenses that they have, this rule of thumb might guide them to a portfolio that’s just not able to do that in today’s low interest rate world. 

Brian: Yeah, those are excellent points. I also think, you know, there’s a, there’s a philosophy potentially outdated, of course. But when you think about that, the day I retire, I need to move to a conservative portfolio. And maybe you do based on your risk tolerance and goals and things of that nature, but that should be what’s driving it, not some arbitrary date because to your point, we are going to be, we are living into our eighties, nineties and a good handful into past that. So, if that adage, or if that rule of thumb is, is generally inadequate, right? Because it doesn’t necessarily align with, or accomplish our goals and objectives, where do you start? How do you build portfolios? What’s your theory around that? 

Tony: Yeah, absolutely. And I think that’s probably the, you know, the key to it is looking at the client’s unique situation and that’s really where we start. We don’t apply a rule of thumb. We’re not using predetermined allocation models that fit in age group, but rather we’re starting with the client and beginning there. Putting together a retirement or cash flow projection that looks out over the next 10, 20, 30 years. So, starting with assets today, that the client has stream of income, whatever that might be today. And in retirement expenses, both the base level spending, as well as maybe aspirational spending goals that they have and understanding what are their long-term objectives, putting that plan together, projecting forward on a conservative set of assumptions around rates of return and inflation and arriving at what we term to be their financial risk tolerance and financial risk tolerance is essentially how much risk does a client need to take, how much growth does their portfolio need to achieve? 

And that is usually a very good starting point for us as to the percent of equity to be allocated within the portfolio, but we don’t stop there. I think it’s important also to consider what we term the client’s emotional risk tolerance, and that is in many ways how much risk can they, can they manage to take, how much are they comfortable with? Because if, if you have a client tossing and turning at night and worse finds themselves in a really volatile moment with losses in their portfolio where they can’t take it and they’re forced to sell that can do irreparable damage to the long-term growth of the portfolio. So, we need to reconcile the financial risk tolerance and the emotional risk tolerance. 

Brian: Tony, I love the way you said that. I mean, it’s one thing for us to use, you know, the analytical side of our brain and say, well, we need X amounts in order to achieve Y but the reality is a lot of the way we view money, it’s very emotional. A lot of people make emotional decisions too. So, to be able to, to bring those two together, to ensure that, hey, you’re on track, but importantly, you can sleep at night. That makes all the sense in the world. So, the other thought of course, is, you know, when you think about these rules of thumb, and I think we truly believe people’s goals, people’s money, people’s dreams. It probably shouldn’t rely on that rule of thumb on things that are just so important in their lives. So really appreciate the answer, appreciate you being on and thanks for coming on today.  

Tony: Thanks, Brian. 

Brian: And if you or anyone else has questions they’d like answers to, they can feel free to email us at [email protected]. Thanks for watching.