Is the Rule of 110 Becoming Obsolete for Retirement Savers?

Are you holding too much stock in your retirement account? According to a new report from benefits administrator Alight Solutions, 401(k) participants average a 69.8% allocation to stocks in their retirement portfolios -- the highest level since June of 2001. The data suggests that savers are taking on more risk than what's recommended by the classic asset allocation rule, the Rule of 110.

The Rule of 110 defined

The Rule of 110 offers a guideline for equity exposure based on your age. To use the rule, subtract your age from 110. The answer is an appropriate percentage of stocks or stock funds to hold in your retirement account.

Image source: Getty Images.

The table below shows the Rule of 110 applied to ages 20 through 65.

Table data source: Author calculations.

As you can see, the relative exposure to equities starts at 90% and gradually shifts down to 45%. That evolution has two goals:

1. To give you access to higher growth rates when you're young.
2. To put you into a more defensive stance as you near retirement.

Younger savers, strong market driving higher equity exposures

The table also shows that the average 70% stock exposure, per the Alight Solutions report, is higher than the rule recommends for anyone 40 or older. The 70% number may be less concerning than the fact that it is a 20-year high in equity exposure for 401(k) participants.

There are likely multiple factors pushing that exposure higher. For example:

1. More millennials are saving for retirement. This younger generation should have higher equity exposure since they don't need to tap their retirement funds for several decades. Still, the older Gen Xers, baby boomers, and Traditionalists, who should have lower equity exposure, collectively outnumber millennials by about 70 million.
2. Recent market growth drives up equity exposures for those who don't rebalance. A strong market raises the relative value of stocks in your portfolio because your bonds aren't appreciating at the same time. The best practice is to address that by rebalancing -- or selling off part of your stock holdings and using the process to buy more bonds. Alight Solutions cites a rising market as a cause for the higher equity exposure. That could signal that retirement savers aren't rebalancing often enough.
3. The stock market has shown double-digit growth in eight of the last 11 years. Younger savers haven't experienced an extended bear market. Older savers may have gotten comfortable with an ongoing, rising market.

The second and third factors can wreak havoc on retirement accounts. Both involve holding too much equity casually, rather than purposefully. That can lead to a big and surprising drop in your portfolio value if the market goes sideways.

Longer lifespans change the formula

The challenge is finding a way to build the retirement wealth you need, without risking too much. Sadly, the Rule of 110 is becoming less relevant at addressing that question. Longer lifespans, rising healthcare costs, and the uncertain future of Social Security put upward pressure on the savings balance required to fund a comfortable retirement.

Notably, the rule has already been modified once for those reasons. It used to be the Rule of 100. The math was the same, but the asset allocations were more conservative. At 35 years old, for example, the Rule of 100 would have you invested in 65% stocks instead of 75%.

Knowing you have a high savings hurdle to reach, it's understandable to think that even 75% equities at age 35 isn't enough. At that point, you still have 30 years until retirement. Why take a 1% yield in a Treasury fund when you can go all-in on an S&P 500 (^GSPC -0.07%) index fund that's growing at double digits?

Dangers of too much equity exposure

Only you can decide how to balance stocks, bonds, and cash in your retirement account. Just make that decision with full knowledge of the risks you're accepting. At 100% equity exposure, you'll feel the full force of every market downturn. At lower levels of equity exposure, the effect is more muted.

You can see how this works in the table below. It shows the performance of funds with different asset allocations between Feb. 19, 2020 and March 23, 2020 -- when the market crashed due to the pandemic.

Table data source: Author calculations.

These funds aren't universally representative of the asset allocations. A different 60%/40% portfolio, for example, would have had slightly different results. Still, you see the trend. The lower your exposure to stocks, the more you're insulated from market crashes and corrections.

Risk comes with the territory

Those crashes and corrections are part of investing. They're bad for your wealth only when you need to sell your stocks and take losses. But they're always bad for your emotional state and stress level.

The Rule of 110 tries to solve for the wealth concern, even as lifespans and savings goals shift. Unfortunately, the rule does not address the emotional piece at all. That's where you have to evaluate your own risk tolerance.

If there's any chance a crash would scare you out of investing, then keep your allocation conservative. Slower progress is better than no progress. 

Or, if you are tough as nails and patient enough to wait for a recovery, a higher equity exposure may be the right strategy.