Wealth creation tips: What '100 minus age' rule is and how you can use it to create a balanced portfolio

Asset allocation is a basic yet crucial step in developing your investment strategy to achieve the ultimate goal of creating wealth. Effective asset allocation can help investors diversify their portfolio and distribute risk to ensure the maximum bang for their buck. The ultimate goal of carefully planning your asset allocation is to maximise your return within a given timeframe and reach your financial goals. The '100 minus age' rule is a simple yet effective way to achieve just that.

What is the '100 minus age' rule?

This thumb rule helps investors determine the ratio of debt to equity in their portfolio. Simply put, it helps you gain the answer that suits you best to the age-long debate of equity vs debt. According to the '100 minus age' rule, an investor's portfolio should comprise 100 minus their age percentage of their surplus funds in equities and the remainder in debt.

How to use the '100 minus age' rule to build wealth?

Proper fund allocation is paramount in a portfolio to maximise the benefit of diversification.

Why diversify a portfolio? Are there any benefits of portfolio diversification?

Diversifying across asset classes can have several benefits for a portfolio, depending on the starting point and the thoughtful inclusion of low-correlation asset classes, points out Rinju Abraham, Vice President at financial services company Scripbox.

The benefits, as Abraham puts it, include:

-enhanced returns

-reduced portfolio volatility drawdowns

-altered volatility of returns

Here's your quick guide to this '100 minus age' rule:

'100 minus age' rule: What's the logic and how does it work?

The logic goes like this: the investor should be able to reduce the amount of risk attached to the portfolio with every year of increase in age.

Think of it this way: Young investors have age on their hands and are better placed to build wealth using equities, which is a long-term proposition as they have a higher risk appetite.

As they get older, they get more risk averse and prefer stable and regular income.

'100 minus age' rule formula and explanation: Does it work at all?

The 100 minus rule works with a simple formula:

100-your age = xx

To put things into perspective, for a 30 years old investor, the formula becomes '100-age (30) = 70', meaning 70 per cent of the investments for such as person should be made in equity and the remaining 30 per cent of investments in debt.

Also Read: Anil Singhvi shares ideas on which mutual funds to buy, recommends a minimum five-year horizon 

'100 minus age' rule example

Clearly, the example illustrates the simple idea behind the rule: the lesser the age, the higher the risk-taking capacity and, in turn, the ability to handle the weather storms of the stock market.

However, as you grow old, your risk-taking capacity reduces, and you would need your money sooner. In that scenario, it is essential that you invest in fixed-income securities which ensure fixed returns.

Now, the catch!

'100 minus age' rule: Pros and cons

Advantages

-Diversified portfolio

-Proper distribution of risk  

-Good returns in the long term

Disadvantages

-It does not take into account the specific performance of stocks and bonds, or the economic environment

-Investor’s risk appetite could be more than stated by the rule

Catch latest stock market updates here. For all other news related to business, politics, tech, sports and auto, visit Zeebiz.com.