Earlier I wrote how historically, stocks have had the greatest potential for return but also had the highest risk. Bonds offer a much safer investment but much lower returns. So the question arises – how much of my investments should be in stocks and how much should be in bonds. Some of this is dictated by personal preference. If you absolutely cannot sleep at night knowing that the value of your investments could temporarily decrease – then stocks may not be the place for you! For most of us, the realization that any price drop is likely temporary is offset by the potential for long-term gains. That still begs the question – how much of my money should be in stock and how much in bonds?
The Rule of 100 goes something like this. The percentage of your portfolio that should be invested in higher risk, higher return stocks = 100- your current age. So a person who is 25 should have about 75% their portfolio in stocks because they have plenty of time for any stock market volatility to be overcome while someone who is 75 would want to have only about 25% in stocks. A significant stock market decrease would have too devastating an impact on a 75 year-old’s portfolio to have more than 25% in stocks.
Two things have happened that have made it necessary to update this rule. First, the interest paid on bonds is a fraction of what it was just a few decades ago. In the 80, the yield on 30-year Treasury bonds was over 11%. Today, the yield is more like 3%. At the same time, people started living longer. Following the Rule of 100, it is possible that someone at retirement age could be missing out on a lot of income and may even run out of money. So modifications needed to be made. Some have advocated that we should be using the “Rule of 110”. So at age 65 we would have about 45% of our assets in stocks a 25 year old would have 85% of their assets in stocks. Others, who are more risk tolerant than myself have even proposed a “Rule of 120.” Personally, I think this is too much risk.
The important thing to remember is that like any other investing rule – the “Rule of 110” should be considered a starting point. It’s a rule of thumb. There are other stock : bond portfolio selection techniques out there – including sophisticated Monte Carlo simulation; however, for most of us the new(er) Rule of 110 is probably a good place to start.