Asset Allocation: Should you follow the rule of thumb?

Finance professionals have for decades cited 100 minus age as a simple and the best asset allocation strategy. What this means is that an investor should hold a stock equal to 100 minus his age and rest should be invested in debt. Therefore, if your age is 35, every Rs. 100 that you invest, Rs. 65 (100-35) should be invested in equities or equity mutual fund and rest Rs. 35 should be invested in debt funds. Five years later, when you reach the age of 40, you should be investing Rs. 60 in equities and Rs. 40 in debt. Following this strategy, every year or any other period that you chose for your portfolio re-balancing, you would decrease your allocation to equities, thus reducing the volatility and risk level of your investment portfolio.

Nevertheless, one can hardly get hold of any research supporting this rule of thumb. On the contrary, there is much research that shows superior asset allocation strategies other than 100 minus your age. One of the problems with this rule is that it assumes one size fits all. That is everyone’s financial planning is done in a similar way. Nevertheless, everybody’s investing decisions is based on their financial goal, their current assets, future income potential, and umpteen number of additional factors.

Various research shows, how well a reducing equity portion from your portfolio, which 100 minus age rule suggests, performs compared to other options. In a poor stock market, such as 2001 and 2011, the 100 minus age allocation approach will give least returns compared to other two options. First is when you keep static allocation that is 60% of your assets towards equity and 40% of assets towards bonds with yearly rebalancing. In the second option, you increase your asset allocation towards equities with your age rather than decreasing equity portion of your portfolio.

Even in case of a rising market, the 100 minus age rule of asset allocation does not give the best result and its performance lies between static asset allocation and rising equity exposure with age. 

The above discussion shows that 100 minus age approach will not give you optimum results and you should take into account factors such as your financial background, your financial goal, returns expectation etc to arrive at correct asset allocation.