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Planning on a Long Retirement? Rethink Your Equity Exposure

New research shows that though retirees have kept robust stock percentages in their portfolios, the risky downsides may not outweigh the limited benefits.

Between longer lifespans and a seemingly never-ending bull market, you might be tempted to invest heavier in equities during retirement than the “110 minus your age” rule dictates. But new research from Dimensional Fund Advisors shows why retirees should be more conservative when it comes to too much equity exposure in their retirement funds. These findings may disabuse retirement savers of the benefits riskier investing offers. Swinging for the fences may be tempting, but a solid base-knock, without risk of a strikeout, may deliver a comparable result.

The Dimensional data, which is based on 100,000 simulations, found that an income-driven asset allocation comprised of just 25% equities offers similar retirement income as a wealth-focused portfolio weighted 50% in equities, but manages longevity risk more effectively.

Income vs. Wealth Investing

New research shows that though retirees have kept robust stock percentages in their portfolios, the risky downsides may not outweigh the limited benefits.

Wealth investing can produce larger returns, but an income-focused approach that uses liability-driven investments can better ensure a retiree has enough money to last the rest of his life.

The research conducted by Mathieu Pellerin found that a 65-year-old with an asset allocation split equally between equities and short-term nominal bonds faces a 30% chance of running out of money during a 30-year retirement. Meanwhile, a retiree with an income-focused portfolio (25% equities and 75% inflation-protected bonds), has just a 20% probability of running out of retirement assets during the same time period.

“High equity exposure in retirement increases the variability of the portfolio, thereby increasing both the probability of running out of assets and the probability of leaving behind a large bequest,” Pellerin wrote.

Not only does the income-focused approach better protect against longevity risk, it also produces retirement income similar to its wealth-focused counterpart. Assuming an investor contributes $12,500 to his retirement fund each year between ages 25 and 65, both glide paths would deliver more than $1.3 million.

While the wealth-focused asset allocation produces an average nest egg of $1,376,458, the income-focused approach isn’t far behind, producing an average of $1,336,764, according to the projections.

110 Minus Age Rule

New research shows that though retirees have kept robust stock percentages in their portfolios, the risky downsides may not outweigh the limited benefits.

The 110 Minus Age Rule is a guideline commonly used for determining an appropriate retirement asset allocation based on one’s age. By subtracting your age from 110, you’ll be left with an appropriate equity percentage for your portfolio, according to the rule. More conservative investors can subtract their age from 100, while those who are more aggressive can use 120.

Using this rule of thumb, a 65-year-old retiree with a moderate risk profile would allocate 45% of his assets to equities and the rest to fixed-income securities. An aggressive investor may have as much as 55% equity exposure. But the Dimensional research suggests the rule may inflate a retiree’s equity exposure. A portfolio primarily allocated among inflation-protected bonds and only 25% equities has better odds of lasting a retiree well into his 90s, while producing enough income to cover annual expenses.

Bottom Line

Retirees and those approaching retirement may be tempted to dial up their equity exposure to capitalize on upward trends in the market. However, research from Dimensional Fund Advisors indicates that an income-focused portfolio comprising 25% equities and 75% liability-driven investments provides similar income as a wealth-focused portfolio with higher equity exposure and higher longevity risk.

Retirement Saving Tips

  • Saving and planning for retirement can be a daunting task, but a financial advisor can help see you through the process. SmartAsset’s free tool can match you with up to three advisors in your area in as little as five minutes. If you’re ready to be paired with a local advisor, get started now.
  • SmartAsset’s free asset allocation calculator can be a welcome resource if you’re looking to rebalance your portfolio or figure out what percentage you’d like to invest in stocks, bonds and cash.
  • Do you know how much you need to save to retire comfortably? If not, check out our retirement calculator to get a better sense of what your needs will be and whether you’re currently on track.

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