Saturday, June 19, 2021

Beware of using the ‘100 minus age’ thumb rule for equity allocation

Have you ever heard about the “100 minus age” thumb rule?


The rule says that you subtract your age from 100 to arrive at the ideal asset allocation for your investments. So, if you are 30, then 100-30 would give 70, which is the percentage of equity you can have in your portfolio. That is, you have Equity: Debt in 70:30 ratio. For someone who is 35, the rule will suggest 65 percent (= 100 - age 35) as the equity allocation. This rule is majorly used to calculate retirement corpus.

One major problem with this rule is that it simply assumes that age alone decides a person’s asset allocation. This not true. Factors such as investor’s risk appetite, goal timelines,tax, and return requirements are the major factors that decide asset allocation as well.


What is asset allocation?

Asset allocation is an investment portfolio technique that aims to balance risk by dividing assets among major categories such as cash, bonds, stocks, real estate, and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time.

A better way to plan?

For example: Suppose you have three goals with time horizons of three years, eight years and 18 years. Now, if you are a moderately aggressive 35-year old investor, other things being the same, you can have different allocations for different goals. So, the three-year goal can have 100 percent in debt. The eight-year goal can have 50:50 in equity and debt, while the 18-year goal can have 75:25 in Equity:Debt. This is a far cry from having 65 percent in equity, mandated by the ‘100 minus age’ rule for a 35-year-old.

Remember – Finance Thumb rules are just approximations. Sometimes it may even derail your Financial Goals.

You can look at them and get an idea of investment in the beginning but eventually, it is best to decide your allocation in line with your goal timelines and risk profile.

Written by - Suketh Shetty

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