Your asset allocation may be the most important decision you make as an investor. In fact, studies have found that asset allocation determines over 90% of the variations in portfolio returns. In other words, get your asset allocation right, and the rest is largely semantics.
Asset allocation refers to how your investment funds are spread across the different asset classes, particularly in stocks and bonds.
Portfolios with more stocks tend to lead to higher potential long-term returns, but also greater risk. Bonds, on the other hand, provide a buffer against sharp downturns, but do not necessarily deliver the same growth as stocks.
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Finding the right balance between these asset classes is one of the keys to successful long-term investing.
But how to determine the right asset allocation for you is a question that can quickly send an investor into a tailspin. Luckily, the easiest asset allocation rule, also known as the "100 Minus Your Age Rule," is so easy even a first grader can do it.
What is the 100 Minus Your Age Rule?
This asset allocation rule is simple: subtract your age from 100 to determine how much of your portfolio should be in stocks. For example, if you are 30, this rule suggests that your portfolio should be 70% stock. The remainder can be in bonds or other fixed income.
"Keep in mind that this isn't a one-time allocation," says John Bergquist, president of Elysium Financial in South Jordan, Utah. "You need to consistently be moving funds from (stocks to bonds) as you age."
If you follow the rule, your risk level will gradually reduce as you approach retirement age. Here is how your asset allocation might change over time if you use the 100 Minus Your Age Rule:
Age | Percent of portfolio in stocks | Percent of portfolio in bonds |
20 | 80% | 20% |
30 | 70% | 30% |
40 | 60% | 40% |
50 | 50% | 50% |
60 | 40% | 60% |
70 | 30% | 70% |
80 | 20% | 80% |
The pros and cons of this asset allocation rule
Rules of thumb can be great tools to keep in your investor toolbox, but they aren't always the best approach. Here are some of the benefits and drawbacks to using this super-simple asset allocation rule:
Pros:
- Ease of use: Just plug in your age and you're done.
- Systematic approach to risk: The rule provides a methodical way to ensure you are taking on an appropriate level of risk for your age.
- Keeps emotions in check: You'll be less likely to make emotional decisions if you have a rule to follow.
Cons:
- Generic approach: The rule's one-size-fits-all approach does not account for your individual goals, needs or risk tolerance.
- Retirement-focused: The rule is designed with retirement investors in mind and does not consider other goals that may not be age-based.
- Risk level may be inappropriate: The rule may lead you to take on too little or too much risk.
- Limited investment guidance: The rule only provides allocations for a stock and bond portfolio, without considering other asset classes, such as real estate or commodities.
Modern Variations: The 110 and 120 Rules
One of the biggest complaints against the 100 Minus Your Age Rule is that it is outdated. Given the longer life expectancies for today's investors and the fact that many choose to work past the standard retirement age, some experts advise using a higher number than 100.
The Rule of 100 "tends to be more conservative than I feel is needed," Berquist says. For this reason, he likes to use the Rule of 120, which states that you should subtract your age from 120 instead of 100.
This would give you a higher allocation to equities – by age 30, you'd still have a portfolio that is 90% stocks. Depending on your risk tolerance and near-term goals, that may be too high for you. In which case, the Rule of 110 could be a better middle ground: subtract your age from 110 to get your stock allocation.
Some experts would even say bonds have no place in your portfolio.
"If an investor is 10, 20 or more years from retirement, I typically recommend no bonds in the portfolio," says Steven Conners, founder and president of Conners Wealth Management in Scottsdale, Arizona.
He says he avoids bonds, especially when inflation is high and can erode long-term returns.
Alternatives to the 100 Minus Your Age Rule
While subtracting your age from 100 may be one of the easiest methods to determine an appropriate asset allocation, some experts recommend a different approach.
The rule is an "oversimplification" that relies on generalizations, Conners says. As a result, it "does not provide the best outcome."
A more sophisticated and comprehensive approach would be to base your asset allocation on your personal situation and your goals. An individualized asset allocation would consider:
- Your risk tolerance: Age may suggest how much risk your portfolio can handle, but it doesn't account for what your stomach can tolerate. A customized approach can help you find a balance between the amount of risk you can comfortably bear both financially and psychologically.
- Financial goals and time horizon: Your asset allocation should be customized for each goal and respective time horizon. It may be fine to have 80% or more in stocks for a goal that's a decade away, but you may need a more conservative approach for that house you want to buy in three years.
- Other assets: Your portfolio is only one part of your financial picture. Other assets like real estate, a pension or Social Security can also affect the appropriate asset allocation for you.
If you don't mind the generic nature of the 100 Minus Your Age Rule, there are easy ways to replicate it in your portfolio that don't even require choosing your investments or monitoring them over time.
Two of the best approaches that rely on this type of model are target-date funds and robo-advisers.
- Target-date funds: These are mutual funds geared towards retirement investors. They have a pre-set glide path that gradually reduces the fund's risk level as it nears the target date. Simply choose the fund that most closely aligns with your retirement year and let the fund manager do the rest.
- Robo-advisers: The sophistication behind portfolio construction varies across platforms, but most robo-advisers will base their allocations on your age, goals and risk tolerance. This provides a more customized approach than target-date funds and allows for planning towards multiple goals.
Both of these approaches are often less expensive than working with a human adviser. However, neither can replicate the customized and detailed approach you're likely to get with an actual person.
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