Driving, Investing and the Rule of 100
Investors have used the “Rule of 100” for decades to judge how quickly they need to reduce the overall riskiness of their investment portfolios. Like any “rule of thumb,” it is intended as a starting point, not exact guidance. It can, however, give you a general idea of how much of your retirement funds should be “at risk” versus “not at-risk” by simply subtracting your age from 100. The conventional wisdom invoked is that you should have less at risk when you are older (because you are closer to drawing on the money you’ve accumulated) than when you are younger. Applying this formula would give a 35-year-old an overall strategy with 65% of his money at-risk and 35% not at-risk. By age 65, 65% would be ear-marked for not-at-risk and the remaining 35% would stay at-risk. Here are a couple of analogies that will help illustrate my points.
Driving Analogy #1 – The Vehicle: We are all on the “road to retirement.” Have you mapped your trip for the quickest route? What kind of car can you afford? Does it get good gas mileage? When was it last serviced? Should you trade it in? All of these questions can be applied to the investing you do on the road to retirement. You need a low cost investment “vehicle” that’s comfortable and meets your needs. As you travel, you’ll have to get your investment vehicle serviced (you’ll want your portfolio re-balanced just like your tires). Maybe you’ll start out in a sports car, but later choose a sedan to better suit your needs. That sports car can be fine when you are younger (just as growth mutual funds, stocks, and similar investments can be), but as you get older, practicality, less risk, and comfort become more important (just as more stable, diversified, and conservative investments may be more appropriate).
Driving Analogy #2 – The Driver: Let’s say we are going to take a trip to Jacksonville. How do we get there? Odds are we will get on I-95 and head north. As we get closer to our exit, what should we do? Signal to get into the right lane? Turn off the cruise control? Start slowing down? “Yes” to all three; then we can make a smooth exit from the interstate. Investors need to do the exact same thing when they approach their “retirement exit.” They need to start “slowing down” their investments and make an orderly exit to more conservative and income-producing options. On the other hand, some folks “drive” to retirement without setting their GPS; they aren’t sure of the exit number; they have to slam on their brakes, and cut across a couple of lanes of traffic, while putting everybody, including themselves, at risk. Don’t wait until your retirement is upon you to start preparing your investments for the “off ramp!”
Has your portfolio been serviced lately? Are you in the right investment vehicle? If you need help, I’ve got a good map and directions!
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.