This week, the first personal finance question we received was about the Rule of 120 for asset allocation, and the question was quite simply, do I agree with this rule? The short answer is no, but I want to explain why this rule is so useful for so many people when dealing with their money.
The Rule of 120 is quite simple.
You take 120, you subtract your age, and that answer is the percent that you should put in stocks.
The remainder goes into bonds.
Now this is a very simple rule, and so the question is, do I agree with this rule? The short answer is no, because the mathematics of doing asset allocation are just more complicated than this.
There are more than two asset classes, numbers don't always go to 10, and by the way, people are in different financial situations and have different tolerances for risk.
But the reason why people find this such a valuable rule is it avoids the two most common mistakes that people make with their money.
The first mistake they make is that they avoid equities because they are afraid of the risk of the stock market.
You have a stock market crash, they take all their money out, and then they don't have enough money in stocks.
But it turns out that it is almost impossible to hit your long-term financial goals without having a significant amount of your money invested in the high long-term returns that the stock market provides.
The second big mistake that people make is that they avoid bonds altogether.
And that mistake is there because people aren't honest with themselves about how they will react when the markets go up and down.
And bonds help stabilize a portfolio, making sure that if something unexpected happens and if you need money, that it's more likely that your portfolio will have that money for you when you need it.
And so the great thing about the rule of 120 is it ensures that people end up putting most of their money in the high returns of equities, but also don't ignore bonds as a stabilizer for their portfolio.
Please note that the information contained on this page is for educational purposes only and should not be considered tax advice. Any calculations are intended to be illustrative and do not reflect all of the potential complexities of individual tax returns. To assess your specific tax situation, please consult with a tax professional.