Due to the lack of financial planning education and awareness amongst many people, the typical investment strategy is to keep money parked in traditional instruments irrespective of their return generating ability.
Now, the older generations have been proposing this asset allocation method to their successors. However, they fail to account for the risk-taking appetite of youngsters. Many assume that what worked for them might work for their family members as well. In reality, investment decisions need to be personalised.
So, what is a suitable asset allocation method?
Your portfolio should result from your priorities and risk appetite, which in turn depend on your age, income, geographical location, investment horizon and the goals you have set. An economical and easy way of asset allocation is the ‘100 minus your age rule’. Let’s understand this with an example.
100 minus your age rule: Example
Priya is 22 years old who has received her first pay cheque and is wondering how much to invest in equity and debt. She comes across the ‘100 minus your age rule strategy’ and does the following calculations:
Investment in equity = (100 – Your age) %
Therefore, the percentage she can invest in equity = 100-22 = 78%
She can then invest the remaining 22% in comparatively safer assets like fixed deposits and government securities.
Understanding the logic
The reason behind such an asset allocation strategy is relatively straightforward. If you are young and do not have many financial responsibilities and dependents, your risk appetite would typically be high. Hence, you can afford to dedicate a large chunk of your portfolio to high return-yielding securities. However, a retired 60-year-old person would not have the same outlook, and such a person would prefer taking a risk-averse path to live comfortably during retirement.
What is strategic asset allocation?
Constructing an efficient portfolio amounts to strategic asset allocation. The idea is to stick with the strategy for a long time; hence, not be affected by short-term market movements.
Say an investor allocates 80% of the portfolio to equity and 20% to debt instruments. After a specific timeframe, the portfolio rises in value and now contributes to 90% of the total portfolio value. Now, they should sell off a part of the equity to get its weightage back to 80%. How does this help? The investor gets to buy low and sell high fulfilling the most fundamental principle of the stock market.
What is tactical asset allocation?
On the other hand, tactical asset allocation method requires the investor to adjust the portfolio weights constantly, depending on future price expectations and market happenings.
You can obtain an expert’s assistance to plan your portfolio better. Having seen the market movements for years now, an expert would be the best person to devise a financial plan for you.
Whatever be your goals, you must have a defined investment strategy. The ‘100 minus your age rule’ is simple to implement and can help you achieve your dreams faster. It’s important to note that this equation alone should not dictate all your investment decisions. Your risk appetite may differ from someone who is the same age as you, depending on other factors such as personality, financial goals, dependents, etc. However, the 100 minus your age rule can be a good starting point.