Rule of 100

Finance 101: The Rule of 100

What is the Rule of 100?

The Rule of 100 is a quick, thumb-nail sketch of how much money a person should have at risk of loss for their particular stage of life.

Although this provides a good basis for starting a discussion with a financial advisor, each person’s situation is unique and deserving of a personalized approach to their investments and objectives.

How does the Rule of 100 work?

Take your current age and subtract it from the number 100. The result is the approximate percentage one should not exceed in investments where there is a risk of loss.

Example:
Basis                                               100
Less Current Age                            48 years
Maximum Amount at Risk                 52 percent

This is my personal example for my own age. The number resulting tells me that I am probably okay with about half of my retirement money in stocks, real estate and other investments which have a higher potential for gain, but also have a potential for loss. Another  way to look at this is your age should be the percentage of safe money you should have.

What are safe investments?

There are investment vehicles where one can put their money where there is no chance of loss of principal. These options are offered by banks and insurance companies. These are sometimes looked upon as “boring” investments, but each carries guarantees against the loss of principal. Safety should not be looked upon as boring when one is looking to their own retirement. Among these investment vehicles are:

• Savings accounts, CD’s and other longer term banking products, available from a bank
• Fixed Annuities, available only from insurance companies, sometimes through a banker licensed to do insurance business

Which is better, annuities or savings?

The two are not mutually exclusive, and I would urge against using either annuities or savings to the exclusion of the other. Annuities are usually longer term investments, and with the exception of immediate annuities for retirees, money which may be needed in the next five years should not be placed in annuity contract. Unlike savings, annuities grow tax deferred until withdrawal. Savings accounts and CD’s are taxed annually. Therefore, annuities which already provide higher interest rates in most cases over savings accounts and CD’s allow for interest to compound and account values to grow more quickly. Savings accounts and CD’s have their earnings taxed annually, reducing the rate of return and removing money from the compounding effect of interest.

Income from annuities also enjoys tax benefits. Income from annuities does not count against the threshold for taxation of Social Security income.

The best use of annuities is in conjunction with savings and CD’s, in addition to long-term capital investments in stocks and mutual funds, based upon the mix suggested by the Rule of 100.

Example 2:
Basis                                               100
Less Current Age                            48 years
Maximum Amount at Risk                 52 percent
Mix:
52 percent stocks and mutual funds
30 percent fixed annuities
18 percent, liquid savings and CD’s

The annuities portion can be placed in either a traditional IRA or a Roth IRA. Whether to use a traditional IRA or Roth IRA depends on a number of factors, and this is a decision best taken one-on-one with your financial advisor. Future issues will discuss the differences between these two Individual Retirement Account options.

© 2008, Monday Hope Financial Services