Knowing how to assess risk is the first step to a strong financial future.
Whether you’re building a nest egg for retirement or simply getting your feet wet in investing, there are a few ubiquitous strategies everyone should be familiar with. One common piece of investment advice revolves around an investor’s risk appetite: the younger you are, the riskier with investments you ought to be (since you have more time to make up for losses when you’re 20 years old than you would at 60 or 70). But how do you determine what’s the right amount of risk? Enter the Rule of 110.
In this article, we’ll be exploring what the Rule of 110 is and how to apply it to your investment strategies. We’ll also look at why assessing risk is so important and what other strategies to consider to minimize your exposure.
What is the Rule of 110?
The Rule of 110 is one of a handful of common asset allocation strategies that every investor should know. In the case of this rule, it’s used as a simple way to determine risk by how much an investor should allocate between stocks and bonds. To calculate risk based on this rule, subtract your age from 110.
For example, if the investor is 30 years old, the Rule of 110 would suggest a portfolio of 80% stocks / 20% bonds. If the investor is 50 years old, that allocation changes to 60% stocks / 40% bonds. The rationale for this is that the younger an investor is, the more time they have to work with to make corrections to any market downturns that can happen during their lifetime. In other words, more time means more opportunities to be risky and recover from any mistakes.
The Rule of 110 has a few variations, including the Rule of 100 (for conservative traders) or the Rule of 120 (for more aggressive traders), depending on an individual’s appetite for risk. Using the 30-year-old as an example, the Rule of 100 would suggest a 70% stocks / 30% bonds split whereas the Rule of 120 would suggest 90% stocks / 10% bonds.
Regardless of which variation you choose, this rule still operates under the principle that the older the investor becomes, the more they should shift their portfolio to more stable assets such as bonds. Still, the Rule of 110 should be considered as a starting point rather than an absolute since an investor’s financial situation, risk tolerance, goals, and other factors may change over time.
Why is Assessing Investment Risk Important?
Investment decisions are only as useful as your ability to calculate risk. If you invest in money without understanding why you’re making the choices you are, you’re effectively gambling your savings and allowing your success (or failure) to be left completely up to chance.
While there’s always randomness to consider with the market and even your best choices grounded in fundamentals yield negative returns, understanding risk is the first step to saving yourself from financial ruin. This is why another rule of thumb is to never invest more money than you can afford to lose; even if everything goes wrong, it won’t decimate your savings and you can still recover.
With that in mind, understanding risk assessment will allow you to determine your own appetite for risk. If you’re young and have plenty of disposable income, you can afford to go all in on your favorite stocks and see what happens – ideally learning from whatever the outcome is as you shape your strategy. But as you get older and life gets more complicated – from raising and supporting a family to extra bills to potential medical issues – you might not be so cavalier with financial risk-taking.
No matter your age, everyone’s risk aversion is different. You can be a conservative investor at age 25 and then trade very aggressively at 50. Some of the most common factors when determining your risk appetite include, but are not limited to:
- Your financial goals – are you investing to retire, to generate a lot of wealth, or to just make extra money compared to the interest you’d make on a CD or savings account?
- Your age – or the amount of time you have to trade before you need the money from your investments.
- Your dependents – a 20-something who’s single and childless can afford to be riskier than a 40-something with multiple children and a spouse – though a divorced 50-something with financially-independent adult children could also invest riskier than the 40-something.
- The purpose of your portfolio – are you waiting on the stock value to increase to then sell those stocks or are you building a portfolio whose dividends provide sizeable passive income all their own?
- Your financial knowledge – how much you know about how investments work and how to identify opportunities in a given market or with certain asset types.
- Your preferred portfolio allocation – stocks and bonds are two of many asset types; you may choose to also hold cash (both domestic and foreign currencies), ETFs, mutual funds, cryptocurrencies, or physical commodities such as gold or silver, all of which can skew risk in different ways.
Build a Retirement Portfolio with Smart Life Financial
No matter who you are or how long you have until retirement, understanding risk is the first step to creating a stable financial future. If you’ve never invested before or are looking to refresh your portfolio, the Rule of 110 is a great way to assess your appetite for risk or to act as a reset point for your portfolio’s allocation in case you’ve been too risky (or not risky enough) in the past.
If you’re unsure where to start or simply need a helping hand to bring your retirement portfolio back into alignment, the knowledgeable experts at Smart Life Financial can help you out. Reach out to us today and we’d love to create a plan that works with you.
