Rule of 42: Your Investing Blueprint for Building Wealth
Written by
Vance Cariaga
Edited by
Gary Dudak
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One of the keys to successful investing is diversifying your portfolio so you’re not too dependent on any single asset or asset class. The idea is simple: If one asset loses value due to economic or market cycles, other assets can pick up the slack and let you keep building wealth.
Some financial experts recommend the “Rule of 42” for spreading your investments over many different assets. Here’s a closer look at this investing strategy and how it can work to grow your money.
What Is Rule 42?
As the name implies, the Rule of 42 is an investing strategy that calls for you to include at least 42 different equities and other assets in your portfolio. You can have more if you want, but you should have no less than 42 — and only a small amount of money invested in each.
Proponents of the Rule of 42 recommend putting your money into a wide range of investments, with most making up only 2% to 3% of your overall investment portfolio. When you have at least 42 stocks and other assets at 2% each, it adds up to 84%. That leaves 16% to put in preferred investments that can provide additional weight and balance to your portfolio.
The key to the Rule of 42 is to spread your investments around to different sectors, assets and equity types. You want to focus on uncorrelated assets so that no two are impacted by the exact same external factors, whether those factors have to do with the economy, regulatory changes, business trends or similar forces.
Why Should You Try This Strategy?
In a column for Seeking Alpha, former investment and commercial banker, Rida Morwa, called 42 assets the “sweet spot” that enables you to shield yourself from substantial risk from any individual asset. It won’t eliminate investment risk altogether — that’s simply not possible with stocks — but you will significantly minimize it.
“By investing in a larger number of holdings, you can reduce the impact that any individual holding can have on your portfolio,” Morwa wrote. “This reduction means that if one portfolio holding is massively outperforming, it’s not going to benefit your portfolio as much. But likewise, if the unimaginable happens and that company completely shuts down and disappears, it’s not going to tank your portfolio.”
Protection isn’t the only goal, however. You also want a way to grow your wealth — and with the Rule of 42, you have at least 42 assets that can provide returns and income growth over time. This is especially important when it comes to retirement savings.
“The goal when it comes to your retirement should be that you have income pouring in from multiple different sources,” Morwa wrote.
If you do adopt the Rule of 42 strategy, make sure you take the time to review your assets regularly. This might seem like a big chore with so many different assets, but, as Morwa noted, you don’t have to invest a huge amount of time.
“If you spend two minutes every three months reviewing each one of your 42 holdings, you will spend only 84 minutes — just under an hour-and-a-half every three months when earnings come out,” Morwa wrote. “That’s not very long at all, to ensure that your portfolio is running healthily and can provide you with stable, steady and increasing income throughout your retirement.”
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