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The flight path asset allocation model


According to Wikipedia – Asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.

Figuring out the proper asset allocation is one of the most difficult challenges that a new investor has to face when she/he starts investing in the stock market. The main problem is that new investors don’t know their risk tolerance until they go through a few boom and bust cycles. Many of my friends started investing in the stock market in the late 90s right before the dot com bubble. When the bubble collapsed, a bunch of them sold off their investments at a loss and swore off stock investing for many years.

I know now that selling stocks in the middle of a bear market is a terrible idea. Young investors actually should look forward to a bear market. This is when you will be picking up the best deals and makes the most money. However, most investors can’t bear to add money in a down market and they usually sell off their stocks to feel safer. Young investors who should have high risk tolerance are actually the ones that have the least experience and don’t know how to handle a bear market.

flight path age base asset allocation model

Recently I stumbled across an interesting asset allocation article at Forbes. Rick Ferri talks about the flight path model asset allocation plan. (See image from Forbes above.) His proposal is that instead of starting off with high equity, young investors should start off with 40% equity (stocks) then ramp up to 70% by the time they are 30 years old. By starting off with less equity, a new investor will have less exposure to the volatility of the stock market. Hopefully this will prevent the cases like my friends who swore off stock market investing and missed out on the subsequent recovery.

I think this is actually a pretty good idea for young investors especially if they haven’t gone through a bad bear market yet. You might think your risk tolerance is high, but can you really stomach a 50% decrease in your investment portfolio? You won’t know until you go through it.

I would like to make a modification here though. Instead of investing in bonds when you’re young, I’d rather stash the money in CDs and saving accounts. When you’re young, there are many capital intensive goals like buying a house, having a kid, and taking international trips. You need cash for those goals. Having more liquidity is a good thing, but you need to have a lot of discipline too. It would be easy to blow $10,000 on a luxury car down payment when you’re in your 20s. 🙂

The other end of the flight path model is at the retirement age. Rick proposed a 40/60 stock/bond split throughout retirement. Now that people are living longer, we need more equity in our retirement portfolio than the previous generations. After 15 years of investing, I’m pretty comfortable with stock market investing and I probably will have some equity exposure when I’m 64. There are other factors though. If I have 5 million dollars at that point, then I can afford to be safer and go with lower equity allocation. My risk tolerance would probably change by the time I get to that age. We’ll see how it goes.

Investing in the stock market is volatile and a big bear market can scare off new investors. The one thing I learn is you can’t get scared off by the bear. You just have to stay the course and keep investing through the ups and downs. If you have 20+ years left until retirement, you will do fine if you just keep adding to your investment. The flight path model might help some young investors stick with the stock market and I think that’s a good thing. If you’re bullheaded like me, then you’ll probably be alright with the regular age base model. (Start off with high equity.)

Do you know anyone who sold off in the middle of a bear market and swore off investing? What do you think of the flight path asset allocation model?

Asset allocation is very personal and any model is just a guideline. It’s probably fine to get you started, but you will need to figure out your own plan. If you need help with financial planning, check out Personal Capital. If your portfolio is over $100,000 they will set you up with a free financial planning session. It’s nice to review your portfolio and figure out a plan for the future.

Sign up with Personal Capital through this link.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, he hated the corporate BS. He left his engineering career behind to become a stay-at-home dad/blogger at 38. At Retire by 40, Joe focuses on financial independence, early retirement, investing, saving, and passive income.

For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.

Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.
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{ 21 comments… add one }
  • Sylvain February 20, 2013, 12:59 am

    Hello Mr RB40

    I didn’t know this asset allocation model and I think it’s not a bad idea. An other advantage of this flight model for young investors is to learn basics of market. They can adapt their strategy during first years, maybe lose a few money and then take more risk reusing their new knowledge

    • Dividend Growth Investor February 20, 2013, 10:48 am

      I do not understand the logic behind asset allocation models. If you have a strategy that works for you, why increase your bond exposure without taking into account what the external market forces show you.

      In addition, these models are based on individuals who follow an asset depletion retirement strategy. If you focus on generating income for paying for your expenses,then these asset allocation models are not that relevant. That being said, if all you have is 100% equities, you are not diversified. But having some fixed income exposure should be fine for you ( like 20 -25%).

      • retirebyforty February 20, 2013, 10:44 pm

        The problem is that young investors do not have a strategy. Even if they know about asset allocation, it’s hard to watch your portfolio drops 30%. Once they gain some experience, then they’ll know you’ll have to keep buying in the down market. For experienced investors, it’s best to stick with what you know works for you.

  • Greg February 20, 2013, 2:36 am

    I’ll start out by saying I’m terrible when it comes to long-term investing strategies. And I’ll probably be working til the day I die because of that.
    But maybe my experience can help others in some way…
    I’ve been in the tech field for 25+ years.
    So, when I started investing in stocks maybe a dozen years ago, I went for tech stocks.
    Yeah, in hindsight, bad idea.
    I’m not a great financial person that scours over all the details and P/E ratios, etc… – I just went with gut feeling and media hype and did what they experts were saying to do.
    I bought into AOL right before it started it’s decline after many stock splits and the constant upward price that had been happening for years.
    I bought Novatel Wireless – loser for me.
    Insignia (mobile device updates over the air) – loser for me – management made millions selling their tech to another company, and then left the company as a shell company with maybe $10 million and no products or services to sell. And the management people that handled the negotionions then went to work for the new company.
    I bought Digital River, I think, or stock in a company in the same market – they sold out for pennies on the dollar I think. We’re not talking huge amounts – I probably paid $2000 and got back $300.
    The point being… every single tech stock I bought, I lost $$$’s with.
    I became dismayed, and quit buying.
    We’re not talking huge dollars here – hundreds or thousands, but not 10’s or 100’s of thousands.

    What I learned… the experts are telling me exactly opposite of what I should be doing.
    Or at least this is my theory.
    They’re saying the masses of public should be buying a stock at just about the time their multi-million/billion dollar customers are looking to sell massive amounts of their stock at a profit. And they need a big market for that to happen.

    I listened, and I bought it, and I lost every time.

    Now when I hear stock experts telling me what I should be doing – I tend to do the opposite.

    I don’t invest in tech companies anymore because of my poor history with them.
    I don’t invest in financial companies – I just figure they’re going to screw me in some way.
    I found that I do like investing in bio-tech/drug companies, and I’ve done well there, despite me not being a specialist in the area, and I’m not even sure I’m really knowledgeable in the area, but it seems to work for me.

    I go to http://www.drugs.com, look for New Drug Applications that are interesting, check into the companies and what they’re doing, I look for companies that are in the $2-$3 range, and doing good things and close to filing an NDA.
    If it looks promising, the stock goes up for the 3-6 months up to the approval/disapproval date.
    If not, the stock was $2-$3, so not a major loss at that price.

    And you know what I find? Experts seem to promote buying the stock right about the time of the decision date by the FDA. And about the time major investors that may have bought it 3-6 months earlier would want to sell massive amounts of the stock and take the profit on the runnup right before the approval/disapproval date by the FDA.

    Yes… I’m very suspicious of stock experts these days 🙂

    But you mentioned many are scared off of buying in a bear market?
    These days, I’d rather buy in a bear market I think.

    What’s the reasoning behind them being named ‘bull market’ and ‘bear market’?
    I’m not understanding how that actually relates to what happens.

    • retirebyforty February 20, 2013, 10:50 pm

      Thanks for sharing your experience. Hopefully it will help some of us.
      I think you are right about the experts. I don’t really listen to them either.
      Great tips with drugs.com. I will definitely check it out.
      I’m trying to stick with blue chips and ETFs these days. It’s not as spectacular, but I’m more concern about capital preservation now.
      From what I understand, it came from the attacking motion? The bull attack up with the horns. The bear smash down. Just what I read somewhere…

  • Greg February 20, 2013, 2:48 am

    Oops, at the end, I mentioned I’d rather buy in a bull market.
    I meant bear there.

    • retirebyforty February 20, 2013, 10:51 pm

      I updated your comment.

  • My Financial Independence Journey February 20, 2013, 2:56 am

    I do know a few people who swore off investing after the recent recession. I feel bad for them because they basically missed the entire recovery.

    Asking people what their risk tolerance is sounds like a great thing to do, until you realize that non-finance professionals have no way of answering that. Should extreme-snowboarders use the aggressive model and shy individuals go with the flight path? And that they’re answers will change based on the current economic conditions. 2006 was all in stocks, 2008 was cash only.

    I went to the Forbes site and read the article. You know what wasn’t there? Data! This is the kind of question (Which model has the best probability of providing you with a sustainable retirement?) that could be answered using historical stock market data.

    So I reserve judgement on the flight path model until someone does the analysis. I will probably be that someone as soon as I find time.

    • retirebyforty February 20, 2013, 10:52 pm

      You’re right. Investing risk tolerance is not the same as say safety risk tolerance. I would love to see the result. It seems to make sense, but we need a study group.

  • Financial Independence February 20, 2013, 5:47 am

    I think in nowadays investors got no choice but to invest aggressively in the stock market.

    I do not think that the bond market can help much, while entry ticket to real estate is simply to high.

    • retirebyforty February 20, 2013, 10:53 pm

      I don’t like the bond market right now either. Once the interest rate rise, it will be more attractive.
      How about REIT?

  • Jane Savers @ The Money Puzzle February 20, 2013, 5:57 am

    You’ve got to know when to hold ’em
    Know when to fold ’em
    Know when to walk away and know when to run
    You never count your money when you’re sittin’ at the table
    Ther’ll be time enough for countin’ when the dealin’s done

    Buy and hold long term. My investment strategy learned from Kenny Rogers’ The Gambler.

    I made decisions about stocks from good quality companies then I buy and hold. I check the prices infrequently and know that ups and downs are part of life. Long term gain is what I am after.

    • retirebyforty February 20, 2013, 10:54 pm

      I like buy and hold too. It’s just easier. 🙂

  • krantcents February 20, 2013, 11:06 am

    An asset allocation is personal. It depends on your tolerance for risk and your personal circumstances. I will never put as much as recommended in bonds because much of my retirement is fixed through Social Security and a pension. In addition, each has COLA although the calculation may change. I also have lifetime medical insurance. All these factors influence my investing. I also have a rather modest lifestyle and will have no debt when I retire. I have already taken some precautions in my allocation by investing in TIPS and healthcare. It seems to reduce some of the volatility. I am still interested in growth although preservation of principal is also important.

    • retirebyforty February 20, 2013, 10:58 pm

      It sounds like you are planning to pass on your wealth. That is a good reason to have more invested in equity.

  • The Passive Income Earner February 20, 2013, 3:13 pm

    I agree with Dividend Growth Investor, you can diversify within equity and figure out an allocation model that works and continue to generate income for retirement. It’s important to know where your retirement income will come from; from income or simply from withdrawal.

    My only goal with holding bonds (through ETFs) is really for having some more liquid investment that I can use to buy more dividend stocks during bear market. The bond/stock ratio allows for tracking the balance of where to put your money. Rebalance every quarter or year. Bonds are up, buy stocks, bonds are down buy more bonds. Unfortunately, I have no bonds yet as I find investments that are appealing to me when I have funds but that would be my theory on having bonds as opposed to have a safer investments. Preferred Shares could be used for that – it’s better from a tax perspective anyway.

    • retirebyforty February 20, 2013, 11:03 pm

      I’m having a hard time increasing my bond % as well. It’s just doesn’t seem like a good investment right now.
      It would be great to retire from income alone, but most people can’t do that. It will require a big portfolio and regular people barely has any retirement saving. It’s not a good situation.

  • Integrator February 20, 2013, 4:38 pm

    I think you need to feel comfortable with the underlying asset class that you invest in to feel truly at ease with your investments. For some people, irrespective of asset allocation, that may mean that they just have to avoid stocks. I’m comfortable with the business models of my dividend paying stocks. Thats why I own them. I went through the 2008-2009 bear market and had major losses. These were amplified by a level of gearing that was ridiculously high. I My lesson from 2008-2009 was to keep aggressively building stock exposure, not swear off stocks, but to limit debt as a way to get there.

    • retirebyforty February 20, 2013, 11:05 pm

      Every bear market is a huge learning experience. I had some margin investment during the dot com bubble and lost some money too. It seems like a lot at the time, but it’s quite insignificant now. Anyway, I don’t invest on the margin anymore.

  • Shawn @ PipsToday February 21, 2013, 8:56 pm

    That’s good representation by using graph, it’s easy to understand. I do not think that’s right ratio “40/60 stock/bond split throughout retirement”, many people are interest in invest on stock, Forex and real estate, here we can buy and hold for long time it’s always retunes good.

  • Anton Ivanov July 2, 2013, 10:19 pm

    The flight path asset allocation method seems interest, I’ve never hear of it before. I would, however, be concerned over the lost growth in the first phase of this method (where you are ramping up your equity allocation). Without doing any math, it seems that a significant growth potential would be lost.

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