Determining the amount of risk that is right for you is dependent on a number of variables. Your age, health, comfort level, and financial need, among other things, will all play a role in setting your assets' level of risk exposure.
You need to feel comfortable with where and how you are investing your money, and a good financial professional will be able to help you make decisions that put your money in places that fit your risk criteria. While there is no single approach to determine investment risk, there are some helpful guidelines.
The Rule of 100 is a general rule that helps shape asset diversification for the average investor. The rule states that the number 100 minus an investor's age equals the percentage of assets they should have exposed to risk.
For example, if you are a 30-year-old investor, the Rule of 100 would indicate that you should be focusing on investing primarily in the market and taking on a substantial amount of risk in your portfolio. The Rule of 100 suggests that 70 percent of your investments should be exposed to risk; 100 – (30 years of age) = 70 percent.
As you can see from the formula, risk tolerance generally reduces as you get older. Much of the flexibility that comes with investing earlier in life is related to compounding. Compounding earnings can be incredibly powerful over time. The longer your money has to compound, the greater your wealth will be. This is what most people talk about when they refer to putting their money to work.
This is also why the Rule of 100 favors risk for the younger investors. If you start investing when you are young, you can invest smaller amounts of money in a more aggressive fashion because you have the potential to make profit in a rising market and you can harness the power of compounding earnings. But at an older age of 50 or 60, it basically becomes more expensive to prudently invest.
You risk not having a recovery period the older you get, so you should have less of your assets at risk in volatile investments. You should shift with the Rule of 100 to protect your assets and ensure that they will provide you with the income you need in retirement.
If a 40-year-old were to lose 30 percent of their retirement portfolio in a market downturn this year, they would have 20 to 30 years to recover it. On the other hand, someone who is 68 years old might only have a few years to recover losses.
At age 68, it's likely that you simply aren't as interested in suffering through tough stock market turns because there is less time to recover from downturns, and the stakes are higher. The money you have saved is money you may need soon to provide you with income, or is money that you already need to meet your income needs.
Obviously, this Rule of 100 is meant as a guide or suggestion, it's not a law. However, when you start to examine risk vs reward, time value of money, and just common sense, it really should in a part of your planning conversation.