There are many rules of thumb for investing. One prominent example is the 60-40 strategy for asset allocation. That means a standard portfolio consists of 60% stocks and 40% bonds.
Younger investors are generally urged to allocate more than 60% to stocks and older investors are advised to allocate less than that.
That’s because younger investors can take more risk in seeking the higher returns from stocks, since they have plenty of time to ride out market declines.
Older investors, on the other hand, would benefit more from the safety that bonds provide.
In a bankruptcy, for example, bondholders get paid before equity holders. And Treasury securities are backed by the U.S. government, which is a good guarantee. Hence the advice to older investors to exceed 40% in their bond weighting.
There’s also the 120 rule. For that, you subtract your age from 120, and the result is the suggested percentage of your stock weighting.
For example, if you’re 30, the rule would have you put 90% of your portfolio in stocks. If you’re 60, the stock weighting would be 60%. The rest would go into bonds.
The idea is the same as mentioned above: When you’re younger you can take more risk, so you want to have more of your assets in stocks. And when you’re older you want to take less risk, so you place more of your holdings in bonds.
Formerly the 100 Rule
For decades it was actually the 100 rule: You subtracted your age from 100 to determine your stock and bond weightings.
“More recently, 120 has been showing up as a more common starting point, partly because average life expectancies have gradually increased,” Amy Arnott, a portfolio strategist for Morningstar, wrote in a commentary.
The legendary Vanguard Founder John Bogle had "advocated using 120, … explaining that the previous guideline came to fruition in an era of much higher bond yields.” And the renowned financial adviser Bill Bengen has recommended using 128.
So what are the advantages of the 120 rule?
“This rule has stood the test of time partly because it’s simple and intuitive,” Arnott said. “There’s a strong link between life expectancy and investment time horizon.”
Avoiding Market Timing
In addition, “linking portfolio allocations to age might lessen the temptation to engage in market timing,” she said. That's the virtually impossible effort to predict when a particular market will rise or fall.
“It also indirectly reinforces portfolio rebalancing, as keeping allocation in line with an age-based target would require pruning back equities after significant gains or adding to them after market corrections.”
To be sure, the rule might not apply to very young investors or much older ones, Arnott said. “A 25-year old investor with decades left until retirement doesn’t necessarily need any fixed-income exposure,” she said.
Meanwhile, some experts have recommended that older retirees gradually increase their equity exposures. They may want the higher returns to keep their portfolios from shrinking too much as they withdraw money for expenses.