Conventional wisdom says that as you get older, you should take less risk with your portfolio. But if you always interpret that advice as meaning that you should give up on investing in stocks, then you're sacrificing one of the most valuable assets you own: the knowledge and experience you've accumulated throughout your lifetime.
Of course, to figure out whether your portfolio has too much risk, you first have to know how to measure that risk in the first place. That turns out to be a bigger problem than you might think. Although there's always a chance that the stocks you own will lose a big fraction of their value tomorrow, you can go a long time without ever suffering the consequences of taking on that risk. Just as a drought can make it hard to tell whether you're in an area prone to flooding, so, too, can an extended bull market lull investors into a false sense of security about the investments they own.
In addition, most standard measures we have to gauge risk fall short of the ideal. For instance, many investors use beta to measure a stock's riskiness. The problem, though, is that beta only looks backwards -- and if the future changes dramatically, beta can blindside you.
For instance, five years ago, financial stocks such as Bank of America
Be smart without giving up your smarts
Nevertheless, even with those difficulties, most people would still agree that however you measure risk, it doesn't make sense for a 60-year-old to invest as aggressively as a 20-year-old would. One frequent argument in favor of reducing risk as you age is that you can't afford the volatility that a risky portfolio entails.
Yet there's a pretty big case to be made for the exact reverse of this advice: that you should be comfortable taking bigger risks as you age. Here's the concept:
- When you start investing, you don't have a clue what you're doing. As you learn, it makes sense to stick with conservative stocks that have clearly understandable businesses -- stocks such as Coca-Cola
(NYSE:KO)or Wal-Mart Stores (NYSE:WMT), for example, where you don't have to know a lot about a highly specialized area to get the gist of what makes their businesses run.
- Conversely, as you gain experience with different industries and market sectors, you're in a better position to analyze all sorts of companies and make predictions about which direction their stocks will move. Moreover, familiarity with phenomena such as investing panics and bull markets gives you an edge over those who may not have seen what typically happens during extraordinary times in the financial markets.
That last point in particular shows how investing experience can be worth its weight in gold. For instance, the energy market has gone from boom to bust and back to reality in the past 18 months. Lots of investors piled into energy stocks such as XTOEnergy
Many would say that some of those investors took on risks that were bigger than they should have. Yet if you have all that experience behind you, in some ways, you're not really taking on any risk at all. Instead, you're just doing something that your expertise tells you is the right thing to do at times like those.
Think twice before you exit
Of course, one benefit of the experience you gain as an investor is understanding that you're not infallible. You may well become more conservative naturally over time as mistakes make you more humble.
Still, think twice before you give in to conventional wisdom and slash your exposure to the stock market. A lifetime of experience in analyzing and picking great stocks isn't something you want to waste, even in the name of asset allocation. Finding the right balance takes work, but the best solution is to continue to use your skills while taking steps to preserve your nest egg for years to come.
There's one investing mistake you simply can't afford to make. John Rosevear exposes this error and tells you how to avoid the big losses it can cause.
Fool contributor Dan Caplinger isn't old yet, but he's getting there. He doesn't own shares of the companies mentioned in this article. Akamai Technologies is a Motley Fool Rule Breakers recommendation. Coca-Cola, Moody's, and Wal-Mart Stores are Motley Fool Inside Value picks. Coca-Cola is a Motley Fool Income Investor selection. The Fool owns shares of XTO Energy. Motley Fool Options has recommended writing puts on Moody's, which is also a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy isn't risky in the slightest bit.