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Wednesday, November 4, 2009
Investment Allocation Rule
Have you heard of the rule of 120 minus age? It is actually an investment allocation rule or a guideline for novice investors like most of us. The rule is pretty simple, just take 120 minus your age, and you will have the allocation in percentage for investment. Example, Ricky is currently 23 years old, which means that he should invest up to 97%.
The idea behind this rule is the younger we are, we need to allocate more for investment, as we can afford to lose. Besides having nothing to lose, the income we are getting when we just started to work is not that high.
Imagine the scenario below:-
Ricky, currently 23 years old and start to work earning 20K annually. After deducting all his expenses other deductions like loan installment, he will still have about 4K (assuming 80% is the expenses in percentage). From this 4K, he should invest 3880 (120-23 = 97% of 4K).
17 years down the road.....
Ricky now age 40, and earning 40K annually. Assuming 80% is his expenses, he will still have 8K left. Using the 120 minus age rule, he should invest 80% of the amount, which amounted to 6400.
From the above scenario, we can see that although Ricky's earning is doubled, but now his investment is just 64% extra, instead of 100% extra. The 120 minus age rule is meant to make the most of the investment capital based on the age, risk and annual income.