Retirement planners like to relay best practices to clients via simple, easy-to-understand rules. Whether it’s sticking to a 4% yearly withdrawal rate or having your bond exposure match your age, these rules-of-thumb have translated into investing strategies for years now.
Of course, these tips come with plenty of research to back them up – a 4% withdrawal rate has a strong chance of lasting a lifetime, for example. But sometimes these rules get turned upside down.
One rule undergoing such an evolution has to do with stock exposure during retirement. For a long time, conventional wisdom has held that your stock exposure should steadily decline as you age. But a growing number of experts think that today’s retirees need to keep much more of their portfolio in the stock market than they might expect.
In the past, when the typical retirement lasted 10 to 15 years, there wasn’t a huge need for stocks in the portfolio. But, the “retirement time horizon has gone up,” says Stuart Ritter, vice president at T. Rowe Price Investment Services and a financial planner at the firm.
With people living longer, the need to take on the risk of stocks (in return for the potentially greater reward) has increased. Though inflation has been low lately, its threat to the value of your retirement savings grows with greater longevity: While a dollar’s value may not decrease much in a decade, it will decrease a lot over 35 years.
These trends have led a growing number of financial planners to advocate a rising equity “glide path.” While this idea isn’t as easy as others to sum up with a platitude, the basic idea is that your exposure to stocks should increase, rather than decrease, as you age in retirement.
Working with the American Institute for Economic Research, Luke Delorme conducted a study to determine the ideal asset-allocation strategy for retirees, assuming a 4% withdrawal rate. The best strategy, he found, was to begin with a 20% allocation of stocks as you enter retirement at age 65, and then increase that allocation gradually every year, over 30 years, until you have a 70% equity exposure at age 95.
“The time that people need to be most conservative is not in retirement,” says Delorme. “but at the beginning of retirement.”
Here’s why: Your portfolio is most vulnerable to risk right after you retire. If the market takes a tumble during the first few years of your extended vacation, then it’s difficult to rebuild your portfolio without going back to work. So keeping stock exposure low at that point protects you from the potential of losing out in the beginning of retirement. But since stocks have historically risen an average of 7% a year over the long-term, gradually increasing your exposure over time increases your odds that your portfolio will last into your later years.
If you have a pension, you can take a bit more risk, says Delorme, who now works as director of financial planning at American Investment Services. You can have a higher allocation of stocks when you leave the workforce, and you can increase stock exposure to 80% within retirement.
T. Rowe Price’s Ritter explains the glide path concept differently. He places client assets into two buckets – one for the first 15 years of retirement, the other for the second 15. In the “first 15” bucket, assets be concentrated in on safe, short-term investment vehicles like bonds and fixed income. The second 15 years’ worth of savings goes into stocks. Placing clients’ money in the two buckets, Ritter says, “helps put the short term volatility” of the market into the context of a broader strategy; investors who know their short-term needs are taken care of are less likely to get scared and pull money out of the market.
While they may not use the term “rising equity glide path,” more financial planners are latching on to the idea of increasing stock exposure in retirement. You often hear of a 50-50 stock to bond ratio for retirees these days. And if you have a higher withdrawal rate, chances are you will also need to take on more risk (unless your nest egg is truly massive). “The biggest driver is less around the allocation of risk,” says JPMorgan Private Bank’s David Lyon. Instead, it’s based on “how much you’re spending on your balance sheet.”
In other words, if you have expensive tastes, then you may want to get used to living with more risk. That’s not a cliché; it’s life.