How Age Affects Risk Tolerance
Traditionally, three risk categories correspond to three simple glide paths. Young investors are often recommended to have the highest levels of risky assets. The equity allocation is stable, then declines steadily after middle age. This approach may not suit each individual for two reasons.
First, the traditional investment glide pattern may not reflect the individuals’ life events. Major life events occur at different ages for individuals. For example, one person may marry young, have children and a mortgage at a young age and plan to retire early. Another person may accumulate substantial wealth, purchase a house, have a partner with significant earnings capability, have children at a later age, and plan to retire well past the standard age of 65. The risk capacity of these two individuals will differ significantly, but not be reflected in the standard investment glide path.
Second, the classic investment glide path recommends that young investors have the maximum of equity in their portfolio. This makes sense in that the young have a entire lifetime of employment earnings to offset any shortfall from equity volatility and the long term compounding effect of the higher equity return will be maximised. However, the young may not be have the financial capacity to withstand short term financial volatility. The young need to be sure they have resources available for current living expenses, often debt repayment, and the capacity to cope with the higher employment uncertainty of the young as they enter the workforce.