Many of us hope to retire someday, but in order to do that, we have to develop a financial plan and follow it to build up savings over a working career. An integral part of any good financial plan is a solid investment strategy to grow your wealth for the future.
It is obviously better to start saving earlier in life as it is easier to build wealth over decades as opposed to just a few months or years. For a more detailed explanation of this principle, see Are You Losing Free Money in Your TSP Account?.
However, many people do not start saving for retirement until later in life (see, for example, Can You Retire on $1000?). So what should you do if you are late to the game on your retirement saving?
The common wisdom in the financial world is that as a person ages, he should shift away from equities (stocks, mutual funds and the like) and shift into more conservative investments, such as bonds or treasury bills.
This theory, known as asset allocation, states that when a person is older, he has a shorter investment timeframe due to, to put it bluntly, being closer to the end of his life, so the investment strategy should become more conservative in nature as he ages. This means shifting away from equities (stocks, mutual funds) and moving towards things like bonds or money markets. The reasoning is that equities are riskier investments and could lose money since they are more volatile (they tend to go up and down in value). You obviously do not want to put money into an investment if you may need the money in a year or two. That investment could go up during that year or two, but there’s also a very good chance it goes down in value.
The problem with more conservative investing such as this, however, is that you can lose money to inflation. The average inflation rate since 1999 has been about 2.4% annually. This means money in a very conservative investment, such as a savings or money market account, would lose money to inflation if it were to earn less than 2.4%, a very likely possibility in one of these investment vehicles.
One financial advisor bucks the trend on this common wisdom of the asset allocation theory.
Personal money management expert and national radio personality Dave Ramsey admits that he’s a contrarian when it comes to this particular subject.
Ramsey points out that, statistically speaking, the average 65 year old who is healthy will live to be over 80. So a 65 year old can easily have 15-20 years to invest, so he or she will have the time frame needed to safely invest in equities, not to mention people in this age range are more likely to be retired and relying on income from investments.
“I’m afraid of what gasoline or a loaf of bread will cost in 20 years,” says Ramsey. “4.2% is the average inflation rate for the last 72 years according to the Consumer Price Index – if you don’t at least get past that, which means you’ve invested it (your money) because you cannot put it into a savings account and make 1%; you are going backwards after inflation (in that case). You’ve GOT to (invest it)! You have 20 some years on average here that you are likely to need that money.”
Ramsey elaborates further as to his skepticism of the asset allocation theory as follows:
“There’s a whole thing out there in the financial community that everybody just accepts as truth, which I don’t accept as truth because I’m a contrarian; I don’t just believe what people say. This idea is that when you hit 65 that you’re going to go downhill pretty quick, so you better start moving your money from equities towards more conservative investments like bonds and money markets (the asset allocation theory). But the flaw in that theory is if you live, because they are ignoring the fact that the typical 65 year old is going to live to 85, assuming reasonable health.
“The problem with the financial community is that some of the things they believe are based in fact and some are based in what everybody else believes. It’s like a bunch of lemmings running off a cliff by themselves as a group. Asset allocation I think is bogus. At 65, I will be investing in equities because I’m going to continue to make money and outpace inflation and they are a better investment than stupid money markets and bonds.”
Ramsey concedes that more conservative mutual funds might be a better approach at this stage of the game, such as a balanced mutual fund (which would contain some bonds) rather than an aggressive growth fund, although he never advocates what he considers to be more risky types of investments at any age, such as buying individual stocks or derivatives.
“There’s two kinds of risk in investing: there’s the risk of the loss of your principal, meaning you put your money into something and lost it or lost some of the value of it, and the other type of risk is that inflation catches you from behind because you’re walking so dad blame slow and it smacks you in the back of the head because you took the advice of some of the financial lemmings out there!,” he exclaims.
But what if you are older, say in your 80s? Surely Ramsey’s advice would not apply to a person in that age range.
Actually, he still recommends it, but for a different reason.
“If you’re 87 and you’re investing, you’re not investing for you anymore. You are investing for you on the short term, but in the long term, somebody is going to pick up that investment when you pass. So you never really reach the point that you are too old to invest, assuming you have heirs that you love and would like to bless,” says Ramsey.
So are you ever really “too old?” “No, you’re never too old to invest,” concludes Ramsey.