Asset allocation, the process of distributing money into different asset classes, can be one of the most difficult decisions. One can follow some scientific method to achieve an asset allocation that can generate high returns. When you approach investment advisors for advice on this, they may suggest different thumb rules that suit your case. One such popular rule is the ‘100 minus age’ rule.
What is the ‘100 minus age’ rule?
The 100 minus age rule states that your portfolio’s percentage of equity assets must be equal to the difference between 100 and your age. For example, if your age is 29, the rule suggests you invest 71% (i.e. 100 – 29 = 71) of your assets in equities.
Technically, the rule supports the concept of ‘declining equity glide path’ where you decrease the allocation to equities each year or once every few years. This leads to reducing volatility and risk level in your portfolio.
The older you get, you would want to have capital security and may become risk-averse. This is just what the rule suggests. Sounds perfect to me! But…
Does it actually work?
The rule generalises people’s risk-appetites and is built based only on the age factor. How can you apply the rule in the case of a person in his early 30s who is risk-averse? Factors, such as risk appetite, planned time to reach the goals, and return requirements, must also be considered to decide the asset allocation.
Illustration
Consider that there are two individuals aged 30 years each. Person ‘A’ was campus selected by an MNC and has a steady growth in the career and package. A well-settled family, assets all over a metro city, unmarried, and stuff. Person ‘B’ has been going through an unstable career, aged and dependant parents, family loans, and has to repay and settle a loan taken from a relative in two months.
Also Read: How is Investing in Mutual Funds Different From Trading Stocks?
If the ‘100 minus age’ rule is to be followed, both of them must allocate 70% of their assets towards equities. Though it is not a big deal for Person ‘A’, it may not be the case for Person ‘B’. This is because the latter has many commitments to take care of and cannot afford to lose capital investment if the equity market goes down. Further, Person ‘B’ cannot afford losing money at this point as the loan repayment is due in two months.
What can be a better approach?
It is recommended to look at the asset allocation from the risk profile and goals’ perspective rather than age. Mind that equities need a long time to fetch the expected returns. If the time remaining to reach your goals are short, go for debt investments.
Speaking of the previous example, Person ‘B’ may invest in debt funds to fulfil the short-term goal of repaying the loan taken from a relative in two months. When it comes to repaying another family loan in about two-three years, Person ‘B’ can allocate about 30:70 in equity and debt funds.
Due to the unstable career, Person ‘B’ has been planning to start a business over a period of 10 years. For this purpose, an asset allocation of 50:50 in equity and debt funds can be favourable.
There is no standard rule that can obey factors, such as your risk appetite, time to reach the goals, and your age. However, you can roughly make decisions by aligning your goals with the nature of investments. You cannot be passive after allocating assets at once. Keep track of assets’ performance and if they are not in line with your goals, re-balance the asset allocation to align them better.
For any clarifications/feedback on the topic, please contact the writer at apoorva.n@cleartax.in
