The 120 Minus Age Rule: A Starting Point for Resource Allocation

Resource allocation is a fancy expression that refers to how much of your wealth is invested in different assets.  Assets are just different kinds of money—cash, stocks, index funds, bonds, real estate, and anything that contributes to a person’s net worth.

A person’s net worth usually consists of different assets.  Maybe you have some money invested in index funds in your 401(k), but you also have some cash on-hand and a high-yield savings account.  How much money you have in those different assets determines your resource allocation.  If you have $40,000 in index funds, $1,000 in your checking account, and $9,000 in a high-yield savings account, you have a resource allocation of 80% stocks and 20% cash.  (Both a checking account and high-yield savings account are considered “cash” since they are easily accessible.)

The 120 Minus Age Rule offers guidance for a person’s resource allocation by suggesting what percentage of a person’s net worth should be invested in different asset classes.  The formula is a starting point for investors worried about how much risk is acceptable in their portfolio.

According to the 120 Minus Age Rule, younger investors should have a much riskier resource allocation than older investors.  Here is how the formula works:

120 - Your Age = Percentage of Assets in Stocks

Stocks are considered a riskier investment, while investments like bonds and cash add stability.  But stocks offer a greater opportunity for growth than bonds or cash/cash equivalents (like that high-yield savings account).  The premise of the 120 Minus Age Rule is that you can accept greater risk to possibly achieve greater growth when you are young.

Here is a quick look at asset allocation based on age according to this rule:

Age	Percentage in Stocks	Percentage in Bonds/Cash
20	100%	0%
30	90%	10%
40	80%	20%
50	70%	30%
60	60%	40%
70	50%	50%
80	40%	60%
90	30%	70%

As you get older, you have fewer assets in stocks and more in bonds or cash to reduce the risk of portfolio fluctuations.

Adopting a more conservative resource allocation as you age is generally a good idea.  We like the guidance of using a trajectory similar to the 120 Minus Age Rule to reallocate resources as you age, but we would not follow it precisely.

Getting Nuanced on Stocks

Stocks are a risky investment.  You can invest $100,000 in a single stock, the company could go bankrupt, and you could have $0.  Literally nothing, wasted-a-year-of-income zero.

But you can invest in stocks without incurring the risk of a single company failing and your stock going to zero.  Enter index funds to save the day.

Index funds let you invest in a regulated collection of stocks that symbolize a significant portion of the overall market.  If one company fails, you do not lose thousands.  You have tiny pieces of hundreds of companies, and the index fund swaps companies included in the fund when a company no longer matches the index fund’s criteria.  This means a failing stock is typically dropped from the index fund before the company goes bankrupt.

Individual stocks carry much higher risk than index funds, but index funds are still usually riskier than bonds and definitely riskier than cash.  However, the reduction in risk is enough, in our opinion, to slow your reallocation to more bonds.  Here’s why:

• Investing in a stock is a bet that a particular company will succeed.  You may pick the next Nvidia, but you may also pick the next Blockbuster.

• Investing in an index fund tied to the S&P 500 is a bet that the 500 largest U.S. companies will collectively succeed, meaning when you consider all the gains and losses of the different companies, you will end up net positive.

One of those is clearly a safer bet than the other.

This difference impacts your asset allocation because if you truly invest in individual stocks, you need bonds to shelter you from the risk.  If you invest in index funds instead of stocks, you can keep a higher allocation of “stocks” later in life because the diversity of the companies reduces the risk in your portfolio.  I am 34 years old and doubt I will own bonds before I reach age 50, but I also prefer index funds to individual stocks.

Bonds or Cash

The bond side of resource allocation deserves similar nuance.  Investing in bonds is still investing and involves some risk, while holding cash incurs no risk but guarantees depreciation over time.  High-yield savings accounts are the happy middle ground where you gain enough interest to account for inflation without incurring risk.  They allow you to keep cash for extended periods of time without losing money.

I do not consider keeping cash or a high-yield savings account “investing” in my personal resource allocation.  My high-yield savings accounts are earmarked for spending or on hold as an emergency fund.  Their purpose is not to grow my wealth.  Their purpose is to fund my life, whether it brings a fun expense like World Series tickets or a tough expense like a medical procedure.  As of the date of writing, these HYSAs contain about $40K of money that I do not consider part of my resource allocation for wealth building.

When looking at your resource allocation, particularly while you are still working, consider only assets that are building your wealth.  This includes bonds, but it does not include cash or cash equivalents.  If the asset cannot possibly grow, it is not part of your wealth building strategy.  This also means if you have an excessive amount of your overall net worth in cash, you should probably put it to work building wealth for you!

Other Assets

The other oversimplification of the 120 Minus Age Rule is its focus entirely on stocks and bonds when there are many other assets that can be used to increase your wealth.  Many investors use real estate to grow their wealth.  Real estate varies in risk, but is likely closer to the stocks on the risk continuum than bonds.  Real estate investments also have similar nuance to stocks and index funds:  Having a single rental property can incur a lot of risk, but having 25 rental units decreases the risk of a vacancy leading to financial ruin.  The type of real estate investment also impacts risk.  Renting out a commercial property inhabited by a business that has been in the same location for 20 years guarantees a low but consistent stream of income.  Renting out an Airbnb property has more volatility with a greater potential for large sums of money on peak weekends.

The rule also overlooks building a business of value and/or investing in small businesses to grow wealth.  It goes without saying that these investments vary in risk.  We have a tax and financial services business: In the past year, the government has overhauled its operations sending consulting firms in the area scrambling, but taxes still exist.  Some industries incur more risk than others.  However, having a small business as an asset provides the freedom to be a bit riskier with your more liquid assets because your wealth is not entirely dependent on stocks and bonds.  

How Do I Allocate My Resources?

The 120 Minus Age Rule is a terrific starting point, but you have to consider what other assets you have and your risk tolerance.  We accept more risk by being more heavily invested in stocks (really index funds) than bonds, but we have cash (really HYSAs) on hand and own a small business.  Your assets are probably different from ours, but any additional asset can allow you to comfortably assume more risk than conventionally suggested.  Weigh your assets and your risk tolerance to determine the right resource allocation for your investments!