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What is life cycle investing?

A growing investment trend that is big in North America but still emerging in Australia is Life Cycle Investing. Life cycle investing aims to invest aggressively in savers’ early lives to reduce the risk of being left with volatile asset valuations in the lead up to retirement.

The theory goes that younger people are far better equipped to bounce back from any financial reverse in their 20s than are people in their 50s.

Reducing risk

The intention of the strategy is to turbocharge capital growth and reduce risk gradually.

That would mean that by the time the saver reaches their mid-50s they would no longer be needing to seek capital growth but would be able to wind back their proportion of “risk” assets to no more than 50 per cent of their overall holdings. Invest the remainder low risk assets such as bonds.

It’s a constructive tweak of the on old notion that savers’ risk assets should in percentage terms not exceed “100 minus their age”.

Meaning that a 50 year old saver should have no more than 50 per cent of their money in risk assets and that by 65 that percentage should have dropped to 35.

Sequencing risk

“Last Decade Risk” is better known to Australian investors as sequencing risk. It is the problem of being heavily exposed to risk assets in the run up to retirement, rather than at the start of an investing career.

Having a “bad decade” in the first ten years of investing had a far smaller effect on the final balance than having it at ages between 55 and 65.

That presupposes one cashes in their investments as a lump sum at the age of 65, something that is becoming rarer now in Australia as retirees opt to keep their assets and extract an income stream. The logic is sound and a worthy consideration for investors at all stages of their life.

 

This article is part of our investing starter series. You can read more of this series here.

These are the views of the author, Andrew Main. This is general in nature and does not take into account your personal circumstances.