This document discusses strategies for limiting stock market risk, such as the Rule of 100. The Rule of 100 states that the percentage invested in stocks should not exceed 100 minus the investor's age. So a 40 year old would invest 60% in stocks. It also discusses balancing portfolios between stocks and bonds. While bonds provide stability, both stocks and bonds carry risk as their prices can fluctuate. Alternative products like market-linked CDs and indexed annuities are presented as ways to participate in stock market gains without risk of losses.

1. Copyright 2013, 2015 - All Rights Reserved
Rule of 100
A Tool Developed by
Financial Professionals
to Limit Stock Market Risk
b
y
By Paul Bullock CLU ChFC GBA RPA FLMI CEBS
Published by Capital Strategies Press / Sponsored by MarketLinking.com

2. Copyright 2013, 2015 - All Rights Reserved
Rule of 100 & 110
Every financial professional knows that the chance of sudden and unexpected
loss is part and parcel to stock market investing. As a result, the rule of 100 has
come into general use. The rule of 100 simply states that the percentage of funds
committed to the stock market should not exceed the age of the investor
subtracted from 100.
% of Funds in Stock Market = 100 – Age of Investor
Age Rule 100 Rule 110
20 80% 90%
40 60% 70%
50 50% 60%
60 40% 50%
70 30% 40%
80 20% 30%
Both rules are useful guides, but they are a sign
that buying stocks, either individually or in a
managed portfolio, is risky and consumers should
take steps to manage that risk.

3. The Stock Market is Always Adjusting
The graph shows the annual price changes of the S&P 500 Common Stock Index, which
is often said to mimic the performance of the entire stock market. Annual price
changes are measured month-end to month-end one year later and includes every
month-end from Jan 1970 to Dec 2012 (504 one year periods). Historically, the market
has yielded substantial gains as well as generated significant losses.
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4. Losses are Guaranteed - if You Stay in
the Market Long Enough
Our study of stock market stability over one year periods showed mixed results. In some years
the market delivered huge gains, in others ruinous losses. The market was up 73% of the time,
but lost money 26% of the periods and broke even twice. The average gain was 8.25% and the
highest gain was 53.37%. However, the biggest loss was 44.76%, almost half of the portfolio.
Loss of a years savings is inconsequential, the true threat from the stock market is the loss of a
large chunk of the retirement nest egg. Retirement funds are built up over time in small
increments. Annual stock market gains are added to these increments and interest begins to
compound, multiplying your savings. Because that savings is continually in the stock market, the
chance of hitting a down year, becomes almost certain. A market downturn, not only creates a
loss for that year, but wipes out years of accumulations in one swipe.
Therefore, techniques like the rule of 100 were developed to bleed money out of the stock market
over time and flow those funds into safer, but lower yielding alternatives.
504 one year periods, from Jan1970 to Dec 2012 were measured from month-end to month-end twelve months later.
This represents a statistical sample of about 4.6% of the potentially 10,920 one year periods if measured from each
business day to the same business day one year later. Only the changes in stock prices were analyzed. Dividends were
ignored in the study which were 1% to 3% during the period and would therefore increase the average yield and mitigate
the gains and losses.
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5. The rule of 100 reduces stock market risk by
balancing the portfolio (replacing some of the
stocks with bonds). Bonds, like stocks, are
sold in the public markets. This makes them
subject to unpredictable changes in price,
very much like stocks. However, since bonds
are ultimately redeemable for their face value,
25% Stocks
75% Bonds
75% Stocks
25% Bonds
well chosen bonds can inject a high degree of stability into a mixed portfolio.
On the downside, bonds historically pay a lower rate of return than common
stocks, therefore, adding bonds to the portfolio will lower the overall return of
the holdings.
Balanced Portfolios
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6. What Can You Expect From Bonds Return?
A study of bond yields for the 92 years shows considerable fluctuations, but also a
long term trading range. (These are the quality of bonds that government regulators
normally allow insurance companies to purchase.)
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7. Balanced Portfolio Using Rule of 100
Age % in Stocks % in Bonds
Portfolio Yield
(Stocks 10% / Bonds 6%)
30 70% 30% 8.82%
35 65% 35% 8.62%
40 60% 40% 8.42%
45 55% 45% 8.22%
50 50% 50% 8.03%
55 45% 55% 7.83%
60 40% 60% 7.63%
The above table shows the returns from balancing a portfolio in accordance
with the Rule of 100. As the percentage of bonds increases, the total yield is
reduced, hopefully, in exchange for lower volatility in the portfolio. However,
the returns above are expected average returns. As we have seen, the
actual annual return results can be unpredictable to say the least.
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8. Bond
Economics
Bond Annual Bond Price at
Coupon Interest -------- Market Interest Rate ---------
Rate Paid 2.5% 5.0% 7.5%
2.5% $25 $1,000 $1,500 $3,000
5.0% $50 $2,000 $1,000 $ 667
7.5% $75 $3,000 $ 500 $ 333
The table shows the price fluctuations of a $1,000
bond as interest rates changes. We pretended that
the bond is perpetual, which allow us to ignore the
price support effects of the bonds eventual pay-off.
WOW! The bond market looks as dangerous as the stock market. A 2.5%
increase in interest rates can drop a $1,000 bond to $500. Of course, the price
could also rise to $1,500 if interest rates fall.
Note: These numbers are a little exaggerated, because bond prices are ultimately supported by
their surrender value. Therefore, a 5 year maturity would respond much less to an interest rate
change, than a 30 year bond, because the pay-off date is much closer. The above prices ignore
these kinds of price supports and are shown solely to illustrate why bonds prices are volatile.
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9. Stock & Bond Combined Volatility
Balance portfolio are used to reduce market volatility and the chances of a large loss in the market
place. However, this technique is not 100% effective. As we have seen, both bonds and stocks can
under go substantial prices change in a relatively short period. These price swings can not be
predicted and can be substantial. Limiting bond holdings to ten your maturities does dampen the
possibility of loss and somewhat stabilize the overall portfolio, but this is only a partial safeguard.
Part of theory of a mixed portfolio is that both stocks and bond prices will not move in the same
directions. Therefore, volatility in one, will be offset by opposing volatility in the other. The graph
above overlays annual changes in the bond and stock market. In some years they cancel one another
out. However, in many situations, they both stress a mixed portfolio in the same direction.
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10. To Summarize - a Balanced Portfolio
• Has lower overall market risk
• Has lowers total return
• Has lower expected return, but a more reliable
projection of return
• Still contains risk, because both the stock and bond
components can move to reduce portfolio values
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11. Bonds are Not the Only Source of Stability
If market linking CD’s and indexing life and annuity policies can provide yields in
excess of bonds, plus complete protection from market downturns, why not use it as
an alternative in our Rule of 100 planning?
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The returns and price volatility discussed and projected herein are taken from historical
studies of commercial bonds and common stocks in US financial markets. However, there
are alternative portfolio management techniques that dampen portfolio volatility and protect
against market losses using an entirely different approach.
Market liking, also termed indexing, places the entire portfolio in bonds and uses the interest
from the portfolio to hedge a stock market index or other asset index. When the asset index
rises, the earnings are credited as interest. If the price of the asset index falls, the loss is
limited to the annual interest used to purchase the market hedge. Market linked portfolios
can be designed to rely entirely on asset price increases or to provide a minimum annual
interest that is augmented with asset prices rise.
Indexing and market linking is a way to participate in stock market gains without the risk of
market losses. Indexed savers are essentially trading some of the market gains, in
exchange for total protection from all market losses. Market linked CDs are issued by banks
and the accounts qualify for FDIC insurance. Insurance companies issue indexed annuities
and universal life policies and guarantee the principal of the policyholders.

12. Copyright 2013, 2015 - All Rights Reserved
For additional information on
market linked and/or indexed
product please visit:
MarketLinking.com
PolicyChallenge.com
These websites contain hundreds of pages of information, insights,
comparisons, historical data, buying tips and financial planning
concepts. Please educate yourself about these unique products.