Who doesn’t love rules of thumb? They are typically an oversimplified solution to a complex question. The only problem with them is that everyone is different. It’s difficult to dish out such broad applications to such unique situations. There is one rule of thumb that I do like. It’s the rule of 100.
I love useless knowledge so here’s a bit for you. Did you know that the phrase “rule of thumb” originated from woodworkers that would use the width of their thumbs to measure approximately 1 inch rather than using a ruler? Now you can’t say I don’t teach you anything!
What Asset Allocation Should I Have?
I overheard a friend of mine say that he was having difficulty selecting investment options within his 401(k). With such a long time-horizon, he was aware of the aggressive strategy he should have but wasn’t sure of the exact allocations. For someone with such a dilemma, the rule of 100 is reliable.
Simply put, the rule of 100 tells an inexperienced investor what percentage to invest in stocks and what percentage to invest in bonds. More specifically, it exemplifies how much risk an investor should take at a specific age. To simplify the calculation: you should have your age invested in bonds, and 100 – your age invested in stocks.
Let’s use me as an example.
- 26 (age)
= 74% invested in equities
= 26% invested in bonds
This rule assumes every investor of the same age has similar risk tolerances, which is not the case. I have encountered a 25 year-old that cringes at the thought of losing a dollar and an 85 year-old that will (without hesitation) bet half of her net worth on black. We are all different so tweak accordingly.
A common adjustment is to add 10% to equities if you are a risk taker and subtract 10% from equities if you are risk averse. So if you are a strapping young lad with a white-haired woman trapped inside of you, it’s fine to go 65-35. In the Intelligent Investor, Benjamin Graham warns never to go outside of 75-25.
- But what if you have 40 years until retirement and historically stocks will outperform bonds? Wouldn’t it make more sense to be 100% equities?
- But haven’t bonds actually outperformed stocks over the past 30 years? Wouldn’t it make more sense to put 100% in a “less-risky” investment that yields higher returns?
Both of these questions are correct. Over the long-term, stocks have seen the highest gains among traditional investments. Also, according to Bloomberg, over the last 30 years (which is a pretty long-term, no?) long-term government bonds have gained 11.5% a year beating the 10.8% increase in the S&P 500. Even so, it would be a great risk to allocate 100% of your portfolio to either investment.
What do you all think of the rule of 100? Is it useful? Is it completely wrong?