Life-cycle investing

Life-cycle investing is a term that covers a range of ways of investing that match strategy to the stage an investor has reached in their life.

The classic approach to life-cycle investing starts with a comparatively high risk, high return strategy that gradually moves to low risk, low return over the years. It can be roughly divided into four phases:

  1. Accumulation: young people with a long time to retirement can invest on a very long term basis, with a heavy equity weighting as equities outperform in the long term (benefiting from the equity risk premium).
  2. Consolidation: As people grow older, and time to retirement shrinks, they need a lower risk portfolio to ensure preservation of what they have accumulated. Their equity exposure should gradually reduce in favour of bonds and other relatively safe investments.
  3. Spending: (also called decumulation) The expenditure of savings in retirement.
  4. Gifting: as remaining expected life span shortens, people with a reasonable savings are likely to find themselves with more assets than they need, and start giving away money.

The simple case is to consider just equities, bonds and gilts. Index linked gilts are particularly safe as they preserve wealth even against inflation. Annuities are also a very safe investment as they guarantee an income for life.

There is an argument for the inclusion of a wider range of investments such as insurance, structured products, and even hedge funds. However, insurance is not exactly an innovation. Derivatives are not well understood by private investors, and to not have a good track record of providing the risk management they are supposed to.

Another challenge to the pattern of investment suggested by most advocates of life cycle investing, comes from considering the lost opportunity to keep investing in equities and other investments with high expected returns.

Life-cycle investing is a popular approach and is currently conventional wisdom. It is possible to buy investments that package life-cycle investing, moving money between funds over the years to gradually adjust exposure from equities to bonds.

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