A commonly cited rule of thumb to determine asset allocation says that an individual should hold a percentage of stocks equal to 100 minus his age. So, for a typical 40-year-old, 60 per cent of the portfolio should be equities or equity mutual funds. No one really knows how this formula became a rule of thumb. We conducted an analysis, through the following cases, to find out exactly how good or bad this popular method of asset allocation really is.
Following the 100-minus-age rule
In the first case, a 35 year old individual - let's say his name is Samir - invested Rs 1 lakh at the start of year 2000 across three equity and three debt mutual funds. Since Samir was 35 in 2000, the 100 minus age asset allocation prescribed that 65 per cent of Rs1 lakh should be in equity funds. The rest 35 per cent should be in debt funds. At the end of every calendar year, Samir rebalanced the portfolio. This means the equity allocation got reduced by 1 per cent every year, for instance, from 65 per cent to 64 per cent as Samir's age rose from 35 to 36 years. Consequently, the debt-fund allocation rose by 1 per cent yearly. This model decreases your allocation to stocks, thus reducing the volatility and risk level of your investment portfolio.
While he began with an initial investment of Rs 1 lakh, Samir had to bring in more money to the table to maintain this asset allocation. This is because Samir did not sell fund holdings to arrive at the correct asset allocation. Any selling may have led to taxation trouble. Hence, he just bought more of debt when he wanted to lower equity exposure and bought more of equity funds when he wanted to cut the overall exposure to debt. Between 2000 to 2017, Samir put in a combined Rs 38.15 lakh, including the Rs 1 lakh initial investment. The total value of his investments stood at Rs 89.17 lakh at the end of the calendar year 2017, when he turned 52. So, Samir's 100-minus-age model helped his money grow by 2.33 times only.
In the second case, a 35-year-old individual Rajesh invested Rs1 lakh across the same three equity and three debt funds in 2000 but did no rebalancing. He spread his money across the six schemes equally (Rs 16,667 each) once. Since he did no rebalancing, he did not need to put in any new funds for the rest of the time period, i.e., until end-2017.
Over the next 17 years, Rajesh's investment across six different schemes brought different results. In his equity-fund basket, the best fund gave an annualised return of 18.29 per cent. The second best gave 12.52 per cent annually and the worst one generated 8.75 per cent. On the debt-fund side, Rajesh's money grew in three streams: 6.27 per cent, 8.63 per cent and 8.24 per cent. Mind you all these returns are in real funds.
Having made a one-time investment of Rs1 lakh, Rajesh's total kitty grew to Rs 6.61 lakh, i.e., his money grew 6.61 times in 17 years. That's much more return than what the 100-minus-age model gave. Also, there was no hassle in this case since there is no rebalancing or fresh investments required.
In the third case, 35-year old Akanksha put all her Rs1 lakh initial investment in the three equity funds that Samir and Rajesh chose. All her money was divided into those three equity funds, with Rs 33,333 going in every scheme.
Since the three equity funds are all the same, Akanksha's best fund generated 18.29 per cent annualised return, the next best clocked 12.52 per cent and the last one delivered 8.75 per cent annualised return over the 17 years. When Akanksha turned 52 around end-2017, she looked at her fund portfolio and it had a total market value of Rs 9.65 lakh, i.e., her initial investment had grown 9.65 times.
With no debt allocation, Akanksha's portfolio contained the most risk and consequently, the returns rewarded her for the risk taken. Like Rajesh, Akanksha also did not have to go through the hassle of annual rebalancing. She bought the funds once and then held onto them.
Date with debt
Meena, a 35-year-old woman, invested all her Rs 1 lakh in three debt funds. Since the three debt funds are the same for all the four cases, Meena's best-performing fund naturally generated 8.63 per cent annualised return over the 17 years, the second-best one delivered 8.24 per cent and the third one laboured to produce 6.27 per cent. As a result of this approach, Meena's Rs 1 lakh investment became Rs 3.57 lakh, i.e., 3.57 times in the 17 years.
Our research indicates that the 100-minus-age allocation approach delivered the worst outcome out of the four cases. Also, to avoid tax issue, one needs to have a lot of monetary resources available and one has to be ready to be able to add to existing investment to achieve asset allocation. Even after taking all the pains, the returns are paltry.
The 100-minus-age approach does not appear to be the best allocation approach to use in retirement. So, don't count on it. Choose your asset allocation wisely.