Age-based Asset Allocation(100-age) rule

One of the basic rule of investing is with the increasing age we should invest in less risky assets like fixed income assets, which means the older we grow, the lesser risk we should take. At old age, our income is less as well as our risk-taking capacity. So while investing we should consider less risky investments like fixed income assets to protect our hard-earned money.

So what should be the asset allocation in our old age? There is a common thumb rule of asset allocation called the 100 minus age rule. According to this principle, individuals should invest in an equity asset class or stocks equal to 100 minus their age. So if your age is 60 years, 40% of your portfolio should be in equities. The rest would be in AAA-rated bonds, government debt securities, and other relatively safe assets.

Key takeaway

1- The basic principle of investing is to reduce risk as you grow older. One of the common rules of asset allocation is to invest a percentage in equity or stocks equal to 100 minus your age.

2 - Nowadays people, live longer, which means that the rule needs to be changed.

3 - Since fixed-income investments offer lower returns, this rule needs to be altered.

4 - It may make sense to hold a percentage of stocks equal to 110 or 120 minus the age rule.

5 - While investing apart from age, you should consider other factors like the age at which you want to retire or the time horizon, and the corpus you will need at that time.

Is there a proper asset allocation by age? 

Your age dictates how much risk you can take on your investment, the general rule says that the younger you are the more risk you can take. This means that the risk tolerance level decreases with the rise in age. So allocation towards equity should be lesser as you are getting older. As per the common asset allocation rule by age, you should hold a percentage of the stock that is equal to 100 minus age. So if your age is 40, you should hold 60% of your portfolio in stocks.

Since life expectancy is growing, earlier the average life expectancy was 60 years now it has reached 80 years even more, so the age rule should change to 110 minus your age or 120 minus your age may be more appropriate.

Does changing investment portfolio allocation by age make sense?

It makes sense to change your portfolio allocation with the increase in age. More money should be allocated to safe investments or fixed asset classes. That is because the older you get, the risk tolerance decreases with age. And if you lose money at this age, you don't have the time to replenish the capital as you are in your nesting age. Rather preservation of capital is more important than taking an unwanted risk as you are closer to your retirement age. So first preference should be given to the protection of your accumulated corpus rather than investing in stocks.

Taking age alone into consideration for asset allocation adequate?

Age alone can not decide a person's asset allocation. Apart from age, some other factors must be taken into consideration in asset allocation. This is the major problem with the 100 minus age rule. Factors such as the risk appetite of the investor, return requirement, and time horizon of his goal must be taken into consideration along with age.

If we will consider a person of age 35, having three goals with different time horizons, let's say three years, eight years, and 20 years. He will have different allocations for different goals. For the short-term horizon of three years, he would prefer 100% allocation in debt and for eight years his asset allocation would be 50 percent in equity and 50 percent in the debt, while the 20-year goal can have 75:25 in equity:debt. This is a far cry from having 65 percent equity mandated by the 100-age rule for a 35-year-old.

The bottom line 

Based on the above facts, age can not only be considered for our asset allocation. Maybe it is a useful tool for retirement planning by encouraging investors to slowly reduce risk over time. But when we are living a longer life as compared to our earlier generation and getting less reward by investing in safe investments, the accumulated corpus may not be sufficient for the rest of our life, it's time to change the 100 minus age rule and take more risk with our retirement fund.