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Which works better – Age based or goal based asset allocation?

There are two schools of thoughts, for asset management. First, is age-based asset management and second is the goal-based asset management. Let’s see what they mean and which works better for you in the modern world of investing.

Asset allocation is an important concept in personal finance. Simply put, it means how much of your money should be invested in which category asset.  There are two schools of thoughts, for asset management. First, is age-based asset management and second is the goal-based asset management.  Let’s see what they mean and which works better for you in the modern world of investing.

Age based asset allocation

This is a simple thumb rule that has been around for a while. The rule says, the number 100 minus your age would give you the ideal asset allocation for your age. Debt exposure should be equal to 100-age, and your equity exposure should be equal to your age. For instance, say you are 30 years old, then 100 minus 30 is equal to 70. So, if you have Rs 100 as investible amount, you should put Rs 70 in equity and Rs 30 in debt instruments. 

Goal based asset allocation

Here instead of age, your financial goals decide your individual asset allocation. For instance, how much you need, when, and what kind of returns you expect. Take for instance, is it a long-term goal like retirement which will come only after 20 years. Or is it a middle term goal like child’s higher education which will come in less than 10 years but more than 3-5, or is it a financial goal which is just around the corner and needs to be achieved after a year. It also factors in the emergencies and can be made more adaptable to change.

100-minus age is a very broad indicator. It may not be suitable for everyone. The biggest issue with this approach is that it clubs everyone in the same box based on age and ignores their individual life circumstances. In fact, even if two individuals have the same age and the same life circumstance, they may have different goals, liabilities, and understanding of risk.

Which is better?

Many are confused when it comes to which asset allocation works better for them. However, most experts agree that a goal- based asset allocation is the right approach.

100-minus age is a very broad indicator. It may not be suitable for everyone. The biggest issue with this approach is that it clubs everyone in the same box based on age and ignores their individual life circumstances. In fact, even if two individuals have the same age and the same life circumstance, they may have different goals, liabilities, and understanding of risk. 

Consider this. Two twin brothers Suresh and Ramesh are 35, and want to invest for their retirement. Suresh wants to retire at the age of 60 and live a retired life of solitude. Ramesh wants to retire early at 40. Suresh has a time horizon of 25 years. With the asset-based allocation 100-35=65, and might be very comfortable investing in mid cap funds. But, that’ isn’t a wise move for Ramesh who has his goal only five years away as mid-caps will take a lot longer to deliver superior returns. 

The goal-based asset allocation strategy is more dynamic and based on your personal need, not some age-old thumb rule. It says, if you need to park money for few days, there’s liquid funds, whether you are 18 or 81. 

The goal-based asset allocation is really personal, after all personal finance should be more about being personal and less about finance. So, it will take into account your time horizon, understanding of risk, and expected returns. 

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