In the investment arena, nuts-and-bolts advice for a member of the millennial generation — as opposed to a pre-retiree or retiree – is usually as different as day and night.
A millennial, who has at least 30 years of work ahead of him or her, is almost always advised to invest most of their assets in the stock market. The premise is that stocks return more than bonds over time and that when you run into the occasional market sell-offs, you have plenty of time to make up for your losses and keep earning more over the long run.
Conventional advice for the retirement set is an altogether different kettle of fish.
Continue to invest in stocks, but mix them with a generous helping of bonds, it counsels, because it’s unwise to overexpose yourself to extreme volatility if you may not live long enough to recover from a steep market sell-off. This, for example, is the modus operandi of so-called target-date mutual funds, which appeal to older investors, base their allocations on retirement dates and put more in bonds than stocks as the years roll by.
But what if this no longer makes sense? What if the investment glide path of retirees should be relatively similar to those of millennials, not markedly different? Retirees with annuities should consider these questions because at least half of their investments lie outside annuities.
New Thinking Is Gaining Traction
This new school of thought is gaining momentum because times are changing. Now, some experts say that some conventional benchmarks, such as subtracting your age from 100 to determine the percentage of assets to put into stocks, is too conservative — and that exposure to stocks should probably rise as you proceed through retirement.
As part of this thinking, there are also new suggestions for dealing with so-called sequence-of-returns risk – the risk of suffering big and permanent losses early in retirement in a bear market, when withdrawals are made from underlying investments. Until recently, the thinking was that it’s best to simply ride this out – that the risk is mitigated as long as the annual withdrawal rate is modest. Today, though, the premise, increasingly, is that retirees should dial back their stock holdings to as little as 20 percent at the start of retirement — when losses in a down market can be devastating — and then ramp them way up later in retirement, well beyond the old ceiling of 60 percent, when losses are less damaging.
This theory is roughly similar to investment advice for millennials. Essentially, it says this: Invest more in stocks than you do today through most of your retirement – except for the initial retirement period of five to 10 years.
Why This Makes Sense
There are three key reasons – and an addendum – backing up this thinking. They are:
- A 30-plus-year bull market in bonds is almost certainly coming to an end. Bond prices will be heading down, not up, in coming years as the Federal Reserve increases interest rates, and what already has become a very lackluster investment will get worse and could actually lose money.
- The investment horizon for most retirees has doubled to at least 20 years in recent decades, reflecting rising longevity. This means money has to last longer, and investing heavily in stocks for the duration is the best bet to make that happen.
- The dramatic shift from pension plans to 401 (k) retirement plans forces retirees to depend more on investment gains for income. You need to earn more from investments if you don’t have a pension — or only a small pension — to back you up.
- The addendum is that higher reliance on stocks requires at least one major move to avert possible catastrophic risk. This is where the strategy of investing less in stocks, not more, in early retirement enters the picture. “You want to have the lowest stock allocation when your portfolio is largest, and that is going to be right before retirement and in the early years after it starts (when withdrawals are still minimal),” says Wade Pfau, Ph.D, a retirement income professor at The American College. “That’s when you are most vulnerable to losing wealth.”
A growing number of mainstream advisors also embrace this new retiree investment approach. Says Andrew Murdoch, president of Somerset Wealth Strategies, a Portland, OR firm that specializes in helping retirees invest: “There is risk in being too aggressive in investing, but increasingly there is also risk in being too unaggressive,” Murdoch says. “Retirees need to weigh the pros and cons of investing in stocks versus bonds and seriously consider investing more heavily in stocks than they have in the past.”
Not Really Radical
The new paradigm for allocating retirement investment dollars isn’t as radical as it may seem. Consider, for example, John Bogle, the founder and former CEO of The Vanguard Group, the nation’s largest mutual fund family. Bogle’s parents were forced to sell their home during the Great Depression and the 87-year-old investment guru has always been a very cautious investor who has long said that investors should have a bond allocation roughly equal to their age. This suggests a very heavy bond allocation for retirees.
What often gets lost in the shuffle, however, is that Bogle has also said that the bond allocation should include Social Security income and pension income if that exists.
For retirees, this boils down to a lower allocation to bonds and a higher allocation to stocks.
Here, specifically, is why. A 65-year-old can estimate the overall value of an annual benefit by multiplying it by 15, some financial experts say. So if this person receives $20,000 a year in Social Security benefits, the total value of those payments is estimated at $300,000.
Assume this 65-year-old has $1 million in investments. The Bogle rule of thumb says he should invest $650,000 in bonds and $350,000 in stocks. If this retiree also has Social Security benefits valued at $300,000, however, this boosts the value of his portfolio to $1.3 million. In Bogle’s calculations, this person has the equivalent of $950,000 in bonds and $350,000 in stocks – but actually invests only $650,000 in bonds.
The upshot? This person is really investing 50 percent of his portfolio in bonds – not 65 percent. The point? Today’s new retirement investment thinkers are evolutionists, not revolutionaries. Retirement investors need not totally agree with them but should carefully consider the implications of what they say.
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