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Retirement Planning Study Turns the Conventional Wisdom Upside-Down

June 23, 2015
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By Thomas Yorke

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Fans of Superman comics — or of the “Seinfeld” episode in which Jerry explained the concept to a mystified Elaine — might be familiar with Bizarro World. It’s a place that’s the opposite of the world we know, where up is down, hello is goodbye, and everything is the exact opposite of what its seems. If you’ve been listening to the conventional wisdom and following the standard protocol on retirement planning, a new study in the Financial Planning Journal just might make you think you’ve landed in Bizarro World.

The ideas that emerge from the study aren’t bizarre, mind you. They’re Bizarro — they turn conventional wisdom on its head.

People’s single biggest fear related to retirement is pretty obvious: running out of money. Given the conventional assumptions about the relative safety of bonds compared with stocks, many financial advisors tend to increase the percentage of bonds in the portfolios of retirees and those approaching retirement, while simultaneously decreasing the percentage held in stocks. Some even follow a guideline that calls for holding a percentage of bonds equal to your current age — if you’re 55, for example, then bonds should make up 55% of your investments.

Here’s where the study by Wade Pfau and Michael Kitces, two well-respected researchers and journalists, takes us to Bizarro World. Their study suggests that the percentage of bonds in an individual’s portfolio should peak just before retirement, and then decline while in retirement. Essentially, the percentage of bond holdings in your portfolio, if shown on a graph, would resemble an inverted “U” shape: few bonds when you are younger, then more as you get older, peaking just before retirement, and then falling in retirement. Pfau and Kitces suggest that stocks should increase to as much as 60% or even 70% of your total portfolio during retirement.

This level of stock holdings for those in retirement, has almost never been considered — or, for that matter, even discussed.

The testing and simulations in the study found that increasing the level of stocks held in a portfolio, during retirement not only lessened the probability of running out of money, but also reduced the magnitude of any potential failure. A bit of mumbo-jumbo perhaps, so let’s just describe these as two “good things” for those in retirement. This is also a very good reason to look carefully at your current asset allocations, especially if you are approaching or in retirement.

One of the key reasons for the success of this model: As you draw down your assets to finance your retirement, the dollar value invested in stocks is relatively stable, even as the percentage is increasing, because your total asset base is declining. Keeping a higher allocation in stocks, according to the study, enables you to participate in the upside offered by stocks, as well as maintain your purchasing power.

Stepping back, your investment portfolio is usually just a part of your retirement income. It’s typically combined with Social Security and possibly a pension of some sort. It’s important to recognize that your Social Security income is similar to interest paid by a bond: Although it adjusts yearly for the cost of living, it’s a predictable cash flow, and it will not increase in value if the stock market goes up. Pensions behave the same way.

This bond-like behavior of both Social Security and any pension income could be a reason to push stock percentages even higher for those in retirement, since these cash flows will not capture any market moves.

Another interesting recommendation from the Pfau/Kitces study is an increase in bond holdings for pre-retirees. This is a bit of a trip to Bizarro World, as well. The generally accepted approach has been to stay aggressively invested in stocks during this period, as a method to drive your retirement capital pool higher. But the study suggests that pre-retirees have the most to lose in a market meltdown and should therefore be in capital-preservation mode shortly before retirement.

Obviously, life has no guarantees — but you should examine all your sources of retirement income, as you might just find that your exposure to bonds, or bond-like instruments, is pretty high, so your stock exposure may need to increase to help catch upward moves and help maintain purchasing power.

After all, the goal is to make sure you’re comfortable and secure in retirement. Unless you live in Bizarro World, that is.

Image via iStock.


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