In the 1980s, the rules for healthy eating were laid down: cut out fats, eggs and salt. But over the past decade or so, what was bad has become good. The just-updated Dietary Guidelines for Americans put eggs back on the menu, and there is even some evidence that too little salt in your diet can be a problem.
These nutritional about-faces are maddening, but the sensible response is to determine whether, and how, to modify your behavior based on new information.
When it comes to retirement rules of thumb, the financial industry is experiencing its own version of new dietary guidelines, and the new rules for navigating retirement seem here to stay.
Take, for example, the long-championed “4 Percent Rule” that you can spend down 4 percent of your assets each year in retirement. As I write in a recent paper, “Brave New World: Investing for Longer Retirements,” this rule is likely to prove less effective in today’s environment of longer lives, fewer traditional pensions and low interest rates, where many people haven’t saved enough to finance a multi-decade retirement.
The sensible thing to do once again is to modify behavior accordingly. But while behavioral changes, i.e. saving more and working longer, will have the most dramatic impact in helping to ensure a fully funded retirement, investors—especially pre-retirees, i.e. individuals between the ages of 50 and 65—also need to consider the composition of their portfolios.
Your Retirement Portfolio: Getting Started
First: ASK YOURSELF THE RIGHT QUESTIONS
Russ talks to Personal Investor Strategist Heather Pelant about the questions to ask yourself when building your retirement portfolio—and the appropriate levers to pull based on your personal situation.
SECOND: FAMILIARIZE YOURSELF WITH THE NEW MARKET ENVIRONMENT
Russ discusses how those facing retirement—and those who are already retired—can think of themselves as their own “retirement Chief Investment Officer”, a huge shift from the pension fund world of previous generations. Another key factor: low for longer interest rates.
Consider Retirement Portfolio Construction Basics
As a general rule, most retirement portfolios should contain more equities, more international exposure and a greater diversity of bonds than many would expect.
To put a finer point on this, consider the following illustrative example of three investors aged 50, 55 and 60, all who plan to retire at 65. Following the investing guideline that portfolio risk should decrease—although not too fast—as a person approaches retirement, let’s assume ex-ante portfolio risk of roughly 11 percent for the 50 year old, 9.5 percent for the 55 year old and slightly below 8 percent for the 60 year old.
If we map these risk levels to some sample long-term asset allocations designed to potentially optimize risk, return and cost, a retirement portfolio with around 60 percent equities, perhaps a bit more, would be most appropriate for an investor with 15 years to retirement. Using the same process—mapping to the portfolio with the most appropriate risk level—would suggest that equity exposure drop by around 10 percent for the 55 year old and another 10 percent for a 60 year old, as the chart below shows.
THE CASE FOR STOCKS in a retirement portfolio
These illustrations may strike many investors as equity heavy; the equity allocations are certainly above those you’d get by following the old rule of subtracting your age from 100. But there are a few factors that arguably justify the stock allocations. First, a longer retirement means protecting purchasing power over a longer period. Equities have historically been better than bonds at protecting purchasing power . Second, while equities aren’t cheap, particularly in the United States, they are much less expensive than bonds. With the interest rate on a 10-year government bond at roughly 2.3 percent, after-tax inflation adjusted returns may well be negative.
CONSIDER More International Exposure
Outside of a larger position in equities, the allocation to international stocks in the sample retirement portfolios is about a third. Again, this may strike some as high, and it’s certainly higher than many U.S. investors are accustomed to having. Still, it’s modest when compared to the position of international equities in global benchmarks. Also, international stocks are, for the most part, cheaper than domestic ones, and a large body of evidence demonstrates that
EXPLORE Greater Diversity of Bonds
Finally, the illustrative bond portfolios contain a broader selection of instruments than you might expect. This reflects both the increasing risk of long-dated government bonds—as rates drop, duration or rate sensitivity has risen—and the fact that traditional bonds have never been more expensive.
CAST A WIDER NET AND RETHINK CASH
Russ and Personal Investor Strategist Heather Pelant take a closer look at cash, examining the effects of having too much (or not enough) in your retirement portfolio and how to strike the right balance for your needs.
The bottom line: The new retirement is one that involves long-term planning and savings coupled with a willingness to consider different types of investments and new approaches to asset allocation.