International turmoil, inflation and rising interest rates have created stress and hesitation in consumers looking to protect their nest eggs and bolster their financial positions. However, by looking elsewhere for investment opportunities, you might be ignoring the 120-age investment rule, reducing your portfolio’s returns. The 120-age investment rule encourages investors to stay in the stock market longer to build more wealth. Working with a financial advisor can help you determine what investment strategy to take with your portfolio.
What Is the 120-Age Investment Rule?
The 120-age investment rule states that a healthy investing approach means subtracting your age from 120 and using the result as the percentage of your investment dollars in stocks and other equity investments. Any remainder should become investments in low-risk assets, including certificates of deposit (CDs), bonds, Treasury bills and fixed annuities.
For example, if you’re 30 years old, subtracting your age from 120 gives you 90. Therefore, you would invest 90% of your retirement money in stocks and 10% into more consistent financial instruments. This rule creates a portfolio that gradually carries less risk.
On the other hand, if you’re 75, the rule’s formula gives you 45. So, you’d have 45% of your portfolio in stocks and the rest elsewhere. This balanced approach makes sense because you’re likely retired at 75 and looking to stabilize your income. That said, the rule still keeps almost half your portfolio in stocks at retirement age, which is a more aggressive approach than investors followed not too long ago.
How the 120-Age Investment Rule Works?
The 120-age investment rule is a guideline for investing, and it’s wise to incorporate it into your investment strategy instead of following it dogmatically. The concept behind the rule is to invest in high-risk, high-reward assets while you’re young. Increased exposure allows you to compensate for market volatility and investment losses, building more wealth in the long run.
For example, the stock market occasionally falls, hurting investment accounts. However, the S&P 500, a stock index reflecting the market’s overall performance, has an average annualized return of 9.4% over the past 50 years. Therefore, if you have decades left to invest before you plan on withdrawing from your investment account, you’ll earn more money in the stock market than with CDs.
In addition, the 120-age investment rule nudges your portfolio into low-risk assets as you grow older. For example, 55-year-old would put 65% of their investments in stocks and distribute the rest into more secure assets. This shift protects your nest egg from dips in the stock market while accruing modest gains. That said, your individual circumstances might cause you to tweak these figures. For instance, if you plan to retire at 62 instead of 70, you might want to decrease your stock allocation to avoid losses.
100-Age Investment Rule vs. 120-Age Investment Rule
Before the 120-age investment rule came about, most investment professionals adhered to the 100-age investment rule. The old rule used 100 instead of 120 for subtraction. However, this approach led to a quicker shift to low-risk, low-yield assets, reducing gains. The meager interest rates of other financial products typically don’t generate enough income (although interest rates have risen in the last year, they are following inflation, which decreases spending power).
In addition, because modern medicine continues to elongate our lives, retired folks are living longer. As a result, the 100-age rule underestimated lifespans and created overly conservative investment portfolios incapable of supporting people in their old age. Because of these issues, the 120-age investment rule has replaced the 100-age investment rule. The new rule keeps portfolios aggressive for longer, giving investors a better chance at generating sufficient retirement income.
How to Use the 120-Age Investment Rule?
The 120-age investment rule isn’t a guarantee that you’ll have sufficient retirement income. Instead, it reveals the necessity for investors to structure their portfolios according to longer lifespans and stay ahead of inflation. Although low-risk assets, like CDs, have guaranteed interest rates that have risen in the last year, they need to provide returns that outpace inflation to be worthwhile.
For example, assets that aren’t risky but return a 3% loss to the current inflation rate. While having a stable base for your portfolio is helpful, diversifying into riskier assets will increase your income potential. Of course, it’s crucial to weigh your individual circumstances and risk tolerance before implementing an aggressive investment strategy.
The Bottom Line
The 120-age investment rule is a theory directing investors to keep a higher allocation of riskier investments for longer. This approach helps build more wealth over time, which is critical for the increased average lifespan of retirees. While the 120-age rule isn’t written in stone, it’s a helpful guideline that can help you maximize your portfolio’s potential, whether you’re retiring in a few years or just starting your career.
Tips For Following the 120-Age Rule
- An investment strategy is rarely as straightforward as dividing your portfolio into two asset types. A financial advisor can help you develop an investment approach tailored to your circumstances. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The 120-age rule can help you at any point in your career. Whether you just made your first deposit into an IRA or want to optimize stock performance, use this guide to manage your portfolio’s asset allocation at any age.
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