Understanding Stock Allocation By Age

The idea is that you take 100 and subtract your age from it and the resulting figure serves as the percentage of your assets that you should allocate to stocks.

One of the most important decisions to make when investing is determining the makeup of your investment portfolio. Creating balance in your portfolio for some people is based on their goals or needs from the investment.

However, for some others, it is a function of age. One way to look at the role your age has to plan in your investment is your risk tolerance and how much time you have to take on risk. Typically, when an individual starts investing from a very young age and doesn’t hold back on re-investing, he or she would be able to take full advantage of the magic of compounding.

Yet, in all these things, there is a method of stock allocation that puts to perspective the fact that age is not just a number. The “100 minus age” rule is one of the most common asset allocation metrics of all time.

The idea is that you take 100 and subtract your age from it and the resulting figure serves as the percentage of your assets that you should allocate to stocks and the rest would be made up of less risky assets like government debt amongst others.

In other words, if the person is 30 now, he or she is expected to have a portfolio that is made up of 70% (100 – 30) stocks. Going forward, the investor is expected to then make adjustments which ultimately involves decrease his or her allocation to stocks (and other risky assets) to account for the changes in age.

What this means is that at 60 years of age, the investor is expected to reduce his or her investments in stocks to 40% (100 – 60). The underlying assumption is that the older we get, the more we are willing to take less risk. We then would opt for the possibility of lower gains so we can have a little more confidence in the safety of our investments.

While this is not an incorrect measure, the focus has been placed on age as opposed to risk tolerance. Focusing on age has its own limitations. For one, in cases where the investor lives longer than expected, it is only a matter of time before he or she runs out of money.

This is even worse off as these investors who are now placed in jeopardy of running low on funds during their later years would no longer have the strength to fend for themselves. Not a great way to end one’s life at all.

On the basis of this, there have been revisions to the rule to more of a 120 minus age rule. The goal is to be able to accommodate more stock investments. Popularly known as the “New Life Asset Allocation” method, it is based on research that has shown that people are living longer thanks to advancements in medicine and technology.

Another challenge with using age is that it generalizes how people respond to risk. It ignores the truth that a 20 year old might be utterly risk averse and a 50 year old might be more risk loving. This generalization also ignores the investor’s financial goals/ investment objectives, income level, amount of dependents and so many more peculiarities of the investor.

Therefore, it is important to note that this rule should only serve as a starting guide to effective decision making. Other factors must be considered before final decisions can be made.

If for anything, the goals of the investor should supersede other generic investment strategies. This is the best way to determine optimal asset allocation and ultimately investment success.

Written by Lawretta Egba.