There is no shortage of advice out there on how to find the right balance between the asset allocation that makes people comfortable (low volatility, but low return), and the asset allocation that makes people money (high return, but high volatility). I’m going to suggest a possible different approach for novice investors.
Disclaimer: I do not recommend the following strategy in any way. These are just ideas to chew on. Think for yourself.
Because high returns and high volatility go hand-in-hand, we’re advised to seek the most risk we can handle while still able to stick to an investment plan and sleep well at night. The most nervous investors end up with low returns either because they have few risky investments or because they bail out of their risky investments at the worst possible time.
Even not so nervous investors can have these types of problems. Toss in some unreasonably high mutual fund MERs, and the end result is that their long-term savings grow to less than half of their potential by the time they retire. What if novice investors were to work on their tolerance for volatility when they’re young?
Imagine a 20-something, Dan, who just started a new full-time job and is still living at home. Dan starts saving 20% of his take-home pay in an RRSP or TFSA as long-term savings. He also saves money in a savings account for short-term desires, such as first and last month’s rent for when he moves out, a used car, and extra payments against his student loan.
What if Dan ignored all the asset allocation advice and just invested all his long-term savings in a Canadian stock exchange-traded fund (ETF) such as VCN or XIU? In addition to seeking the high returns from stocks, Dan would be seeking experience with stock volatility. He’ll have lots of time to change his asset allocation once his savings grow to $25,000 or $50,000.
We could even teach Dan to cheer every time his ETF dropped in price because he knows he’ll be able to buy even more units with his savings. With any luck, Dan would experience at least one significant drop in stocks prices in the few years it takes him to build up $25,000 or $50,000. This might help him calmly choose a higher-reward asset allocation for the long term and comfortably ride out the inevitable downturns over the decades.
Humans are adaptable, especially when they are young. Instead of treating our tolerance for risk as a fixed trait we carry around for our whole lives, what if we tried to teach young people to build a greater tolerance for uneven portfolio returns and stay focused on long-term goals with any savings designated for the long term?