The 120 minus age rule is a simple guideline used in financial planning to suggest an appropriate asset allocation strategy, particularly for investing in stocks and bonds. It advises subtracting your current age from 120 to determine the percentage of your investment portfolio that should be allocated to stocks. The remaining percentage would then be allocated to bonds.
Understanding the 120 Minus Age Rule
This rule serves as a quick and easy way for individuals to gauge a suitable mix of aggressive (stocks) and conservative (bonds) investments based on their life stage. The core idea is that as you get older, your investment portfolio should generally become more conservative to protect accumulated wealth, as you have less time to recover from potential market downturns.
Here's how to calculate it:
- Start with 120.
- Subtract your current age. The result is the suggested percentage of your portfolio to invest in stocks.
- The remainder is the suggested percentage for bonds.
For example, if you are 30 years old:
- 120 - 30 = 90
- This suggests 90% of your portfolio should be in stocks and 10% in bonds.
If you are 60 years old:
- 120 - 60 = 60
- This suggests 60% of your portfolio should be in stocks and 40% in bonds.
Here's a quick look at how the allocation changes with age:
| Age | Stock Allocation (120 - Age) | Bond Allocation (Remaining) |
|---|---|---|
| 25 | 95% | 5% |
| 35 | 85% | 15% |
| 45 | 75% | 25% |
| 55 | 65% | 35% |
| 65 | 55% | 45% |
| 75 | 45% | 55% |
Why the Rule of 120?
The underlying principle of the 120 minus age rule, and similar guidelines like the "100 minus age rule" or "110 minus age rule," is rooted in the concept of risk tolerance over time.
- Higher Stock Allocation for Younger Investors: Younger individuals generally have a longer time horizon until retirement. This allows them to take on more investment risk, as they have more years to ride out market fluctuations and benefit from the higher potential growth of stocks.
- Increased Bond Allocation for Older Investors: As investors approach retirement, preserving capital becomes more critical than aggressive growth. Bonds are typically less volatile than stocks, providing a more stable income stream and a cushion against market downturns, thus reducing overall portfolio risk.
This rule provides a straightforward way to align an investor's portfolio with the general expectation that risk capacity diminishes with age.
Advantages and Limitations
While the 120 minus age rule offers simplicity, it's important to understand its benefits and drawbacks.
Advantages:
- Simplicity: It's incredibly easy to understand and apply, making it accessible for novice investors.
- General Guidance: Provides a good starting point for asset allocation, especially for those who are unsure where to begin.
- Risk Adjustment: Automatically suggests a decrease in equity exposure as one ages, aligning with a common financial planning principle.
Limitations and Considerations:
- One-Size-Fits-All: This rule does not account for individual circumstances such as:
- Personal Risk Tolerance: Some younger investors might be very risk-averse, while some older investors might have a higher comfort level with risk.
- Financial Goals: Different goals (e.g., buying a house, early retirement, specific education funding) may require different strategies.
- Income Stability: Individuals with very stable income might tolerate more risk.
- Existing Wealth: Someone with a large existing nest egg might have different needs than someone just starting.
- Other Assets: The rule only considers traditional investment portfolios and doesn't factor in other assets like real estate or pensions.
- Market Volatility: It doesn't adjust for current market conditions or economic forecasts.
- Bond Definition: It broadly refers to "bonds" without specifying types (e.g., short-term, long-term, government, corporate), which can have varying risk profiles.
- Historical Performance: Based on historical average returns and volatility of asset classes, which may not always predict future performance.
Alternatives and Personalization
Given its limitations, the 120 minus age rule is best viewed as a simple heuristic rather than a definitive strategy. Many financial professionals recommend a more personalized approach to asset allocation that considers a broader range of factors.
- Other Age-Based Rules: Variations like the "100 minus age rule" (more conservative) or "110 minus age rule" also exist, offering different starting points for stock allocation.
- Risk-Tolerance Questionnaires: Many financial advisors use detailed questionnaires to gauge an individual's psychological comfort with risk.
- Financial Planning Software: Advanced tools can model various scenarios and help optimize portfolios based on specific goals and risk profiles.
- Professional Advice: Consulting a certified financial advisor can provide tailored guidance.
Ultimately, while the 120 minus age rule offers a straightforward baseline, a truly effective investment strategy should be dynamic and regularly reviewed to align with your evolving life stage, financial objectives, and personal risk comfort.
