There are many rules of thumbs that guide people in all facets of life, and investing is no different. The world of investing has tons of its own rules of thumb that people have devised in the hopes of helping investors navigate the tricky waters of investing. While there are so many to pick from, I have highlighted three of the most popular investing rules of thumb.
120 Minus Your Age Investing Rule Of Thumb
Asset allocation is an important part of investing. The age old adage used to be that your investment portfolio should have 100 minus your age invested in stocks with the rest invested in a portfolio of bonds. So, for example, past thinking would be that a 30 year-old investor would have 30% invested in bonds and 70% invested in stocks. Now, many financial planners have changed the investing rule of thumb to the investor’s age subtracted from 120 instead of 100. So, under that same scenario, an investor would be invested in 90% stocks and only 10% bonds. Many investors have found themselves risk adverse after the recent recession, and trends have started to revert back to the one hundred minus age investing rule of thumb.
The Rule of 72 Investing Rule Of Thumb
Most people are familiar with the Rule of 72. The Rule of 72 says that your money will double based on the annual rate of return that you earn divided by seventy-two. So, for example, if you have a mutual fund that earns the stock market average rate of return of 8% annually, you can expect that your money in the fund will double every nine years (72 divided by 8). This rule of thumb is a great quick guide that can help you figure out your opportunity cost for different investments. Would your money do better invested in a rental real estate that doubles in value approximately every twenty years or would your money be better invested in a certificate of deposit earning 3%? This investing rule of thumb will help you determine and make those kinds of quick calculations.
4% Withdrawal Rule Investing Rule Of Thumb
The one thing that strikes fear in the heart of retirees is the possibility of outliving the money that they have set aside for retirement in their Golden Years. One way to avoid this is to use the 4% withdraw rule of thumb. The rule of thumb protects your principal when you start withdrawing money from your investment portfolio. By withdrawing 4% including dividends, interest, and principle during the withdrawals, you will hopefully withdraw less than your principle will earn for that year. Many empirical, academic studies have been conducted using sophisticated models using Monte Carlo simulation. And, a 4% withdraw rate has been found to provide investors with the best possible probability of not outliving their nest eggs in retirement. While these rules of thumb are great, they are still simply rules of thumb. They do not have to be followed exactly, and in many cases, you may not want to even do that. Rules of thumb are a great starting point to help you manage your investments and portfolio.
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