Do the basics of selecting asset allocation based on "retirement date" change if you are retiring early? For example, do you pick a target retirement based on your early retire date, or based on a normal age 65 retire date so you do not become too conservative too early.
I do realize that the bottom line is selecting asset allocation based on your risk tolerance, but how do you adjust for age?
I define my portfolio and the risk I take based on stages as it pertains to amount invested, yearly deposits and the gains of the portfolio measured against my expenses and my contributions.
1) Starting out
this means my contributions are higher than my account balance
or my contributions are a significant percentage (think 10-20%) my account balance.
2) Accumulation
this means my deposits on an annual basis (like a $5000 Roth deposit) are higher than the dollar gains in the portfolio (meaning $50k earning 10% is 5k). My contributions increase my portfolio as much or more than my portfolio gains.
3) Growth
Growth (to me) means that my deposits are a fraction of my portfolio gains each year. If my annual contributions to 401k+Roth are 20k, and my porfolio generates more than 20k of growth on its own (think 200k-300k earning 10% which is 20k-30k).
4) Stability
This means the annual portfolio gains are more than I spend each year. This phase needs to occur before retirement can be considered. Once this stage is reached, a person has true financial independence. If I spend 40k per year, this means my portfolio is generating more than 40k.
5) Draw down
this is what I call the point of no return. This means I need to sell assets in order to meet income needs. If I need 40k of withdraws, and the portfolio generates only 35k of gains, then the 5k difference is "draw down".
I point this out in phases because as far as asset allocation goes, phases 4-5 have a much different allocation than 3 and 3 has a different allocation than 1 and 2.
When starting out and accumulating, asset allocation matters little. Over any 1-3 year period a portfolio will be highly volatile. A person has little control over markets at all, so when starting out, if person started in 1996 vs 1998 they would see lots of different behavior in both the markets, and their reactions too it. Most people starting out will not truly know their true risk tolerance either.
When portfolio is in growth phase, a specific allocation is used. Probably highest equity exposure of all phases is in growth mode. Growth mode is also where other risks are taken- like starting a business, investing in riskier stocks (like owning company stock, micro caps or sector funds).
When portfolio is in stable phase, the risks taken in growth phase need to be removed or reduced. This might mean selling off a business, reducing equity exposure, or removing sector funds or overweighting of asset classes for returns sake to balancing asset classes for stabilities sake.
**MY main premise is each person knows when they need portfolio to be stable, and when returns are more important than stability or consistency of returns**
When in draw down phase, taking market risk out of the equation may help things.
If the phases are measured based on what the portfolio is doing for you... for example if in Growth mode, why "gradually" ratchet down risk over a period of 10-20 years? You will know when you need stability based on your life, your age, your expenses. When you enter that phase, you make the changes necessary you are comfortable with.
Same with draw down, if you see you have entered the "point of no return" and you need to sell off assets each year to meet income/expense needs, there are changes you will make to portfolio even though during stability or growth those same changes would have been "bad".
You adjust for your situation. I suggest defining it based on where portfolio is relative to current expenses, and how much you contribute each year.
Examples-
A person which wants to retire at age 50 and contributes 40k annually to a current portfolio of 400k with 60k of annual expenses sees the above situation much differently than a co-worker of same age who plans to retire at 65, contributes 10k annually to a portfolio of 200k with same 60k of annual expenses.
Because the retirement timeframes and portfolio values are different, its possible the person with a later retirement date takes more risks because timeframe in accumulation and growth phases is longer.