One of the most important decisions DIY investors have to make is how much of their money should they should allocate to high risk, high reward investments like stocks and how much to lower risk, lower return investments like bonds.
Each investor has to make this decision for themselves. Some of the major factors to consider when trying to determine asset allocation include;
- Your risk tolerance. If you are going to lose sleep every time the stock market has a bad day you probably should not be a DIY investor and should seek the help of a financial advisor.
- Your timeline. When do you plan on spending any of the money you have invested? If it’s 20 years from now, you are better able to absorb the risk of a short term decline in the stock market. If it’s 20 days from now, you probably don’t want to risk losing any of your money and should look at something even safer than bonds like a money market fund.
- Your overall financial picture. How much debt do you have? What’s your income? What other assets do you have? Do you have kids and other people who are financially dependent upon you? All of these factors should be considered when deciding your asset allocation.
You might be thinking this is sounding really overwhelming, is there some kind of formula to at least get me in the ballpark?
Yes, there is, it’s called “The Rule of 110”.
The rule of 110 is a rule of thumb that says the percentage of your money invested in stocks should be equal to 110 minus your age.
So if you are 30 years old the rule of 110 states you should have 80% (110–30) of your money invested in stocks and 20% invested in bonds. If you are 50 years old, the rule states you should have 60% of your money invested in stocks and 40% invested in bonds.
The idea is rather simple the younger you are, the longer you have until retirement and are better able to weather the storm of downturns in the stock market so it makes sense to be more aggressive. in the early phase of your life, the primary goal is to build your wealth.
If you are nearing retirement and plan on living off your investments in the short term, you would have less time to make back any losses in the stock market. Once you near retirement age the name of the game changes from wealth creation to wealth retention.
The rule of 110 can be altered depending on your risk tolerance. Some people who have more appetite for risk go by the “rule of 120” which would mean a higher allocation towards stocks. While some people who have less appetite for risk for by the rule of “100” which would mean a higher allocation towards bonds.
To quickly illustrate the difference consider how the three variations of the rule would impact the asset allocation of a 50-year-old investor.
Under the rule of 100: The investor would allocate 50% towards stocks and 50% towards bonds
Under the rule of 110: The investor would allocate 60% towards stocks and 40% towards bonds
Under the rule of 120: The investor would allocate 70% towards stocks and 30% towards bonds
No matter which variation of the rule you choose the basic concept remains the same. Early in your life, it makes sense for most investors to allocate more of their money towards stocks while as we get older we begin to shift our allocation in favor of bonds.
So there you have it, a simple rule of thumb to help DIY investors decide how much of their money to allocate toward stocks and bonds.
What do you think of the rule of 110? Which variation of the rule (100,110 or 120) do you think fits your preferences the best? Let me know in the comments
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This article is for informational purposes only not all information will be accurate. This should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.