William Wathigo Wamwea
Customer Experience Specialist, Customer Relationship, CRM systems operator, Inter-Department Operability, Escalation Management, Team Member, Leadership, Agile
Published May 13, 2024
Personal finance and investment management can overwhelm those without a firm financial background. The financial planning realm operates under various rules of thumb that simplify complex concepts into easy-to-understand guidelines.
When we think of investing, the rate of return is usually the first point of concern.
Most investment rules of thumb focus on asset allocation; the 10-5-3 rule of investment is one such rule. It is derived from the book by James O’Donnell: The Shortest Investment Book Ever: The Wall Street Secret for making every dollar count. This rule helps to determine your investments' average rate of return, with stocks potentially giving a 10% return, bonds at 5%, and cash giving a 3% return, respectively.
However, this rule is not set in stone; it only provides a helpful framework for making informed investment decisions and managing expectations.
Asset Allocation
There is a valid reason to use this matrix when considering your investment portfolio.
Since they are considered risky assets, 10% of the return is allocated to stock or equities. With risk comes the promise of higher returns. Bonds are allocated 5% based on their less risky characteristics. Because of this, they offer consistent but lower returns. While cash provides easy and quick access to funding, its growth potential is considered minimal at 3%. Cash in this case applies to emergency funds that call for easy access when you encounter unexpected expenses.
Risk tolerance and investment goals should be the main drivers for your asset allocation.
The Rule of 72
Time is a crucial determinant of which investment strategy to apply in finance.
It is important to note that the 10-5-3 rule is best suited for long-term investments, 15 to 20 years. The rule of 72 helps an investor estimate the time it will take for their money to double at a given rate. Combining these two rules offers a clear way to evaluate your investment decision and its potential outcome.
Drawbacks to the 10-5-3 rule
A rule of thumb is merely a guideline; every investment strategy carries the risk of loss.
The 10-5-3 rule is no exception and should be applied with a degree of flexibility. The actual rate of return is susceptible to factors like inflation and market volatility; therefore, it is advisable to periodically adjust your investment portfolio with these conditions in mind. Consulting a financial adviser is advisable since they better understand the nuances of different investment options and can tailor your portfolio to align your financial needs and goals.
In a nutshell, the 10-5-3 rule of investment provides a simplified strategy that helps investors determine their asset allocation for the long run. It helps in setting realistic financial expectations and making informed financial decisions. Therefore, the 10-5-3 rule is best suited for young investors who have time to ride out market volatility. Moreover, the emphasis on diversification is strategic; spreading your assets into different asset classes is good risk mitigation. However, like all rules of thumb, it should be used as a guide rather than a directive. Always consider consulting a financial adviser for all your investment and portfolio management decisions.
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