It is commonly recommended to adjust your investment asset allocation as you get older, gradually shifting towards more conservative investments (i.e. less stocks, more bonds). This traditional approach has merit on the basis that at some point you are likely to switch from accumulating to withdrawing and have a shift in mindset to protect capital more than grow capital. But age and time are not the only factors when designing an appropriate portfolio. In some cases, maintaining or (dare we say) increasing stock exposure throughout retirement may better serve your needs. Here’s why some retirement “rules” are meant to be broken.
Besides time to take risk, willingness to take risk and ability to take risk are variables that should matter when determining how a portfolio is constructed. For example, an individual may be a “risk-taker” and willing to experience higher volatility in exchange for the prospect of higher returns – but they may not have the capacity to take that risk if they are very dependent on their assets providing for current income needs. Likewise, someone may be sensitive to ups and downs psychologically, but have plenty of financial resources to withstand a high degree of market risk.
A balance is often struck between these personal factors, and the financial goals at hand. Some goals may not be realistically achievable without a certain amount of risk, such as maintaining purchasing power for living expenses over time. One of the benefits of having sophisticated financial planning software is the ability to test different scenarios with varied goals, and separate needs from wants. With this capability, we can help identify the capacity for risk within the financial plan, as well as the likely impact of taking different approaches.
The willingness, or more emotional side of risk, is often uncovered in conversation, which is one reason we dedicate time up front with new potential clients and keep up recurring engagements with existing clients. There is a potential danger in letting emotions about volatility or the unknown drive portfolio decisions – we are often prone to overreact, subject to biases, and have a fear of loss. These can result in futile attempts at market timing and costly turnover. One does not want to disregard feelings entirely when establishing an investment objective, but one should try to recognize when a behavioral response might derail a well-designed long-term plan.
A seemingly counterintuitive approach to asset allocation suggests that the portion in stocks stays constant or increases while in retirement. Potential benefits include mitigation of longevity risk, inflation hedging, and higher growth for multigenerational wealth transfers. If market returns are poor in the early years of retirement, increasing stock exposure ensures that one can dollar cost average into markets at lower valuations. If markets are good in the early years, then there is less to worry about overall by getting a boost in available capital.
Keep in mind that a portfolio depleted too heavily by withdrawals may not be sustainable under any allocation model, even if returns are more favorable than expected. A detailed forward-looking plan can help prepare expectations for future spending and identify both strengths and weaknesses ahead of time. The bottom line is that your asset allocation does not need to default to a certain stock/bond mix based solely on age, as there is more to your life than just how old you are.
Additional Resources:
- Read 100% Stocks in Retirement? by Heritage Financial’s CEO, Sammy Azzouz.
