When planning for retirement or managing an investment portfolio, one of the key considerations is how much risk to take. The 100-age rule is a popular, simplified approach to determining how much of your portfolio should be allocated to stocks versus bonds. Let’s dive into what it is, how it works, and its advantages and limitations.
What is the 100-Age Rule?
The 100-age rule is a straightforward formula designed to help investors determine their ideal stock-to-bond allocation based on their age. The rule suggests that you subtract your age from 100 to find the percentage of your portfolio that should be allocated to stocks. The remaining portion should be allocated to bonds or other more conservativ
e investments.
For example:
- If you’re 30 years old, the rule suggests that 70% of your portfolio should be in stocks (100-30=70), and 30% should be in bonds or safer assets.
- If you’re 60 years old, you would allocate 40% to stocks and 60% to bonds.
The logic behind this is that younger investors have more time to ride out market fluctuations, so they can afford to take on more risk by holding more stocks. As you age, the goal shifts towards preserving your capital, so your portfolio leans more towards bonds, which are typically less volatile.
Why Follow the 100-Age Rule?
The 100-age rule is appealing for its simplicity. It offers a quick, easy-to-understand way to manage risk based on your stage in life. It’s particularly useful for people who don’t have the time or expertise to dive into more complicated asset allocation strategies.
Here’s why many investors consider this rule:
- Age-appropriate risk: Younger investors can afford to take on more risk since they have time to recover from potential market downturns. As you age, you may want to protect your savings, so reducing exposure to risky assets like stocks is prudent.
- Simplicity: Asset allocation can be overwhelming with all the factors to consider, from risk tolerance to market trends. The 100-age rule provides a starting point, removing complexity and giving a straightforward guideline.
- Automated Adjustments: The rule naturally adjusts with time. As you age, your allocation to bonds increases automatically. It’s a hands-off approach that ensures your portfolio evolves with your changing risk profile.
Pros and Cons of the 100-Age Rule
While the 100-age rule is simple and intuitive, it isn’t perfect for every situation. Here are some advantages and disadvantages:
Pros:
Simplicity: It’s easy to apply without needing a deep understanding of markets or risk management.
Helps avoid emotional investing: It provides a rule-based approach that can help investors stick to their plan during market ups and downs.
Encourages age-appropriate risk: By gradually shifting away from risky assets, it aligns with common investment wisdom—taking more risk when you're young and reducing risk as you near retirement.
Cons:
Too conservative for some investors: With rising life expectancies, the rule may leave some investors under-exposed to growth assets like stocks in their later years. Many financial experts argue that a higher allocation to stocks could be appropriate even as you age.
Ignores individual risk tolerance: The rule doesn’t account for personal risk tolerance. Some younger investors may be more conservative, while some older investors may be comfortable with more risk, depending on their financial goals and circumstances.
Doesn’t account for other assets or income sources: If you have a pension or significant savings outside your portfolio, the 100-age rule may not fit. It also doesn't consider other factors like debts, liabilities, or the potential for future expenses.
Adjustments to the 100-Age Rule
In recent years, some experts have suggested modifying the rule slightly to account for increased life expectancy and the need for higher returns in retirement. For example, some recommend using 110 or even 120 minus your age instead of 100 to provide more exposure to stocks throughout your lifetime.
For instance:
- If you’re 30 and use the 110-age rule, you would invest 80% in stocks (110 – 30 = 80) instead of 70%.
- If you’re 60, the 120-age rule would suggest keeping 60% in stocks (120 – 60 = 60), which could offer more growth potential in retirement.
These adjustments provide a more aggressive stance that could lead to better long-term growth, especially for those with longer time horizons or who are more comfortable with market volatility.
Final Thoughts
The 100-age rule offers a helpful starting point for investors to think about risk and asset allocation. Its simplicity is its greatest strength, but it’s important to remember that it’s not a one-size-fits-all solution. Adjusting the rule or combining it with a more comprehensive financial plan that includes personal goals, risk tolerance, and other assets can make it more effective for your individual situation.
Ultimately, the best asset allocation is one that matches your financial goals, time horizon, and comfort with risk. If you're unsure, consulting with a financial advisor can help tailor a strategy that's right for you.
Watch the video below for a deeper understanding.
