Retirees Need More Than TIPS

 |  Includes: TIP
by: Kevin Feldman

If you picked up the WSJ this morning, you saw "Why Stocks Are Riskier Than You Think" greeting you on the cover of R1 along with the graphic of a man about to drop into a chasm. (Ever wonder why "good" investors are always pictured on a tropical beach drinking something out of a coconut and "bad" investors about to, literally, fall off a cliff?)

There were some sensible parts to Bodie and Taqqu's take on the current set of difficult choices retirees face in investing for their golden years like separating "needed" from "wanted" living expenses in retirement.

I would also have agreed with the authors that investors shouldn't be focused on recouping losses from the financial crisis through taking excessive risks now, except I'm not sure what data they are looking at suggesting that boomers about to retire are piling on equity risk to try to recover losses.

Most of the retirement research I've seen suggests pre-retirement investors have either held steady in their asset allocation or have been reducing equity risk in favor of bonds, which is also not surprising given the large baby boomer cohort headed into retirement. Mutual funds flows which have been steadily away from equity and into fixed income following the financial crisis would also paint more of a picture of "de-risking" portfolios versus taking excessive risks.

But let's put aside for the moment the question of whether the authors have diagnosed the correct disease and get to the treatment: TIPS (NYSEARCA:TIP). Yes, you read that correctly: TIPS, in large doses. At precisely the historical moment when most treasuries are generating zero or negative expected future real returns, we should all be significantly increasing our allocation to TIPS in order to generate the future inflation-adjusted income to fund our "needed" retirement expenses. I won't even get into the financial exotica they would have you consider for the remaining part of your retirement portfolio because for most of us, there won't be any leftover money.

The most astonishing thing about this article (it's actually in the headline) is the authors believe that "most people can get the money they need for retirement without gambling heavily on equities," which simply isn't true. I mean if there were a nearly risk-free way for most of us to fund a comfortable retirement, wouldn't we take it?

The reality is that most U.S. working-age investors were already under-saved for retirement going into the financial crisis and we've only just begun the process of repairing personal balance sheets, with much of that coming from debt defaults and restructuring of mortgages versus a dramatic uptick in retirement savings. We have a long way to go before "most people" can realize their retirement savings goals - and that's with the compound growth of equities (and maybe some high quality corporate or international bonds) working with them to increase their nest egg.

Interestingly, in trying to bolster their case against equities, they stumble into the behavioral finance trap of "recency bias" by noting that bonds have outperformed stocks (by a thin margin) over the past 30 years, without noting the highly unusual nature of the time period involved, where we witnessed a dramatic decline in inflation and interest rates starting in the 1980s and ending with bonds at current record low yields following a financial crisis unmatched since the Great Depression.

For retirees looking forward instead of back 30 years, it would seem even more prudent today to follow the wisdom of low costs, balance and diversification of holding stocks and bonds that the authors question if for no other reason than most government bonds have an expected real return of something close to zero in the years ahead. Most of us are going to need a little more than that to fund a happy retirement.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.