What should your stock allocation be at your retirement date, or in different words, how much risk (variability) should you tolerate near and at retirement? I discussed this issue in a series of posts earlier this year (see links at end), and recently the Wall Street Journal (WSJ) published an article (paywall) about it.
The WSJ characterized the question as a debate between investing “to” versus “through” retirement. “Target-date” mutual funds illustrate the difference. These funds aim at particular retirement dates, and as the date approaches, the managing company reduces stock allocations gradually to levels it considers ideal for people starting retirement.
Some firms maintain target-date funds from 2010 (people already retired four or so years) to 2055 (young people with a 40-year career ahead of them).
BlackRock and Wells Fargo are in the “to” group, and at retirement their target-date funds have only 38% stocks (BlackRock) and 27% stocks (Wells Fargo). These risk averse funds should experience little variability as investors approach retirement. The goal is getting to retirement without “last-minute harm to your nest egg.”
Fidelity and Vanguard are in the “through” group. At retirement Fidelity’s target date funds have a stock allocation of 55%. Vanguard’s is 52%. Their goal is to capture growth and ward off longevity risk.
All these firms have higher stock allocations during the early and middle career years; Wells Fargo and Vanguard have 90% stocks in their 2055 target-date funds. And they all taper toward their respective retirement date stock targets.
The Big Guys v. Later Living—I
Like the big guys, I recommend that retirees reduce their stock allocations as they approach retirement. But I’m not managing others’ money and don’t need to be specific about a retirement date stock allocation.
I simulated a portfolio of 50/50 stocks and bonds over the last 14 years, and it performed well, with the caveat that retirees need to moderate their inflation-adjusted withdrawals if they begin to creep above the 4% level. Without inflation adjustments, the portfolio grew slowly over the period to the point were the withdrawals were only 3.3% of the portfolio.
Alice, our model retiree, uses four Vanguard funds covering domestic and international stocks, REITs (Real Estate Investment Trusts) and bonds. She maintains 43% in bonds and 57% in stocks and REITs
In Retirees Can Wrestle Investment Risk and Win I added a key point: stock allocations should follow an individual’s retirement goals and plans. This is different from the target-date funds of the four firms mentioned above.
Some people approach retirement with a minimum of savings; others have plenty. Some people plan to rely on their portfolios primarily for regular living expenses. Other people plan many special projects or goals that require specific amounts of money at specific times.
Special goals include helping grandchildren through college, touring in a motor home, buying a second home, self-insuring for long-term care, among others.
To the extent these goals need specific and large amounts of money and are near and specific in time, lower stock allocations are appropriate for the money planned for the special needs. (See Killer Moves … )
The Big Guys v. Later Living—II
After retirement the big firms tend to recommend dwindling stock allocations through retirement, whereas I (and some others) advocate gradually increasing stock allocations. As retirement proceeds, careful (about withdrawals) retirees should see their portfolios gradually grow while their life expectancy shrinks.
They will be building a buffer between what they need and what they have. The potential consequences of a sharp stock market drop slowly becomes less important.
An investor who begins retirement at 65 may live 30+ years. A 50/50 or 60/40 allocation between stocks and bonds would very likely support an annual withdrawal of 4%. But 15 years later at age 80 that same retiree may have 50% more money, and, depending on health, 5 to 15 years life expectancy. Absent a looming special need like long-term care, she can shoulder higher withdrawals and more risk and aim for more potential growth.
We have support for this view in a new article in latest issue of the AAII Journal (American Association of Individual Investors), cited in a previous post.
Retirees should tailor stock and bond allocations to their particular plans.
Using a portfolio for mostly annual retirement withdrawals gives rise to lower stock allocations near and at retirement, but once the portfolio grows and life expectancy declines in the years after retirement, higher stock allocations can increase growth without jeopardizing withdrawals.
If retirees use a portfolio to fund special plans or goals that need specific amounts of money at specific times, they should assess each goal (Killer Moves … ) and adjust stock/bond allocations accordingly.
Other Recent Posts on Risk:
Images of Investment Risk, March 6, 2014
Managing the Danger of Investment Risk at Retirement Time, March 26, 2014
Retirees Can Wrestle Investment Risk and Win, April 4, 2014
Killer Moves Can Help Wrestle Lumpy Retirement Spending, April 29, 2014
Make Money by Managing Investment Risks in Retirement, May 11, 2014