100 minus age equity rule: What is the key to a successful investment? One way is to diversify your asset allocation. It’s very important to diversify our asset allocation across equity and debt. So, now you must be wondering as to how can you decide the proportion of your investment in debt and equity? For years, a commonly cited rule of thumb has helped simplify asset allocation, which is popularly known as ‘the 100 minus age equity rule’.
What is the 100 minus age rule?
This method is used for asset allocation in the financial world. One just has to subtract age from 100 to identify how much of your portfolio should be allocated to equities. For instance, if your age is 60, then the logic says you can invest 40% in equity.
Let us understand this through an example, the 100 minus age rule:
1) If you are in your 20’s (100-20=80), then your asset allocation should be 80% in equity and 20% in debt (FD, bonds etc).
2) If you are in your 30’s (100-30=70), then your asset allocation should be 70% in equity and 30% in debt (FD, bonds etc).
3) If you are in your 40’s (100-40=60), then your asset allocation should be 60% in equity and 40% in debt (FD, bonds etc).
The simple idea behind the rule is, the lesser the age, the higher the risk-taking capacity. However, as you grow old, the risk-taking capacity reduces, and you would need your money sooner. In that scenario, it is essential that you invest in fixed income securities which ensure fixed returns. One of the most basic principles of investing is to gradually reduce your risk as you get older.
What is the drawback of the 100 minus age rule?
Age cannot be the sole factor in deciding the allocation. One major problem with this rule is that it simply assumes that age alone decides a person’s asset allocation. Other factors such as investor’s risk taking capacity, long-term or short-term goals, financial goals, time horizon and returns requirements are the major factors that decide asset allocation as well. Investments should not be dependent on any single criterion since no person’s financial situation remains the same.