The world of investing is so complicated that we often jump at thumb rules. One much-abused thumb rule is ‘100 minus age’ to get you to your ideal asset allocation. So if your age is 30, you invest 100 minus 30 (70 per cent of your portfolio) in equities and the rest in debt options.

An Indianised version of that (to account for lower longevity) is 80 minus age.

This may sound simple, but the truth is that it may not get you to your financial goals.

Required return
Just think of a private sector employee who, at 50, has just managed to wrap up his other commitments and is looking to save Rs. 1 crore by retirement.

The 80 minus age rule would require him to park 30 per cent of his portfolio in equities and 70 per cent in debt and hold on for 10 years.

Assuming stocks earn a 15 per cent CAGR and debt 7 per cent (on a post-tax basis), he would need to invest nearly Rs. 50,500 every month for 10 years to get him to that ₹1 crore target. What if he simply can’t afford to save that much?

Bumping up the equity allocation to 70 per cent and debt down to 30 per cent would require him to save at Rs. 42,000 a month.

But if even that seems impossible, he may have no choice but to invest his entire surplus in equity funds, and keep his fingers crossed. He should then make sure to redeem his fund at least three years before retirement day, to protect from market vagaries.

While this is, no doubt, an extreme example, it just goes to show that the returns you need to make to get to a corpus is a far bigger influence on your asset allocation than your biological age.

Time to target
Another factor far more important than age is the time you have left to meet the goal. Just consider a mid-thirties couple who are keen to enrol their daughter in an engineering college three years from now. While 80 minus age would dictate pouring 50 per cent of their savings into equity funds, that would certainly be a foolhardy course for them to follow.

Past experience suggests that bull phases in the Indian markets typically last for three-five years, after which a big crash ensues.

This makes equities a very poor investment option if your horizon is just three years. The best course for that couple, therefore, would be to forget about equities and invest 100 per cent of their savings in the highest return-bearing debt option (maybe tax-free bonds?).

Income or capital gains?
A third factor that should play a big role in your asset allocation is liquidity. If you want regular income or cash flows, you will need high allocation to fixed income. If you are an aggressive seeker of capital gains, you can bet your shirt on equities.

Consider a 60-year old single woman who has just retired from a top government job and is earning a pension of Rs. 50,000 a month.

Now, the 80 minus age rule would require her to park just 20 per cent of her money in equities.

But if she is happy with her monthly pension and wants to save up for a vacation in Europe in 7-10 years’ time, there would really be no reason for her to avoid equity funds. In reality, though, many Indian retirees make the opposite mistake.

They bet heavily on equity funds with their retirement proceeds to earn a regular income (equity fund dividends are tax-free). That’s a very poor decision, because given the tendency of equity markets to zoom by 70 per cent in one year and tank by 30 per cent in another, they can hardly be relied upon for ‘regular’ income.

Can you handle risk?
A final flaw in the 80 minus age rule is that it simplistically assumes that a person’s risk appetite is correlated to his age. So while you’re young and frisky, you’re supposed to love a bumpy ride from the markets.

As you get older, volatile markets are assumed to make you queasy. But is that really true? Many 20-somethings with dependent parents and children to support are hardly good candidates for equity funds, where market volatility can decimate capital or impede exit, whereas many financially secure 60-somethings, with no dependants or financial goals to meet, may have quite a stomach for risk.

So much so that they don’t mind blowing up a few thousands every month, playing the market.

Two types of investors again, who would lose out by following the 80 minus age rule.

To cut a long story short, if you’re deciding on your asset allocation, forget about the 80 minus age rule.

Start with your financial goal and the time you have left to meet it. Back-work to decide on your asset allocation.

Aarati Krishnan
This article was published on August 1, 2015, in BusinessLine (The Hindu)