One of the issues we frequently come across when dealing with clients is helping them with their struggle on how conservative they should be with their investments in retirement. It seems that clients are bombarded by the financial press and conventional wisdom into believing that once they retire (or get close to it) they need to become very conservative investors. For many clients, they are struggling to balance what they’ve always heard in the media against their natural inclination to still have some risk in their portfolios. In many cases, the clients are right! More risk than they’ve been told they should have can be okay.
Now before we get into the meat of the article, we should point out that we are speaking in generalities here based on what we’ve seen in our group of clients. Obviously, there is no “one size fits all” piece of retirement advice and what’s appropriate for you based on your financial situation and risk tolerance may not be appropriate for someone else. Indeed, we have retired clients whose portfolios run the gamut from all bonds to all stocks.
What Conventional Wisdom Says
The conventional wisdom, illustrated through many target date retirement funds, says that as you near retirement, your asset allocation should follow a “glide path” of ever increasing conservatism. For example, here is the asset allocation for Vanguard’s target retirement series of funds.
Vanguard funds start getting more conservative about 25 years out from retirement. Their two current retirement funds have approximately a 60% allocation to bonds for their Target 2015 fund and 70% for their Current Retirement Fund.
What We See in the Real World
The problem with an overly conservative asset allocation as a default is that it ignores the historical return patterns of the market and what investors’ true timelines are.
Let’s start with the issue of retirement. If you retire at full retirement age, around 67 in the US, your life expectancy is around 85 on average. Some of your investment portfolio is being managed with the expectation of being used tomorrow, next week, next month, or next year. But another portion won’t be used until almost 20 years from now!
From 1926 to 2015, the stock market (as measured by the S&P 500) had a positive return for every rolling 20-year time period. Additionally, returns were only negative 6% of every rolling ten-year time period and 15% of every five-year time period.
Looking back at the Vanguard asset allocation chart, it’s curious why bond allocations begin to increase 25 years out. For most younger investors, the biggest challenge we’ve seen is finding room in their budget for them to make adequate contributions to retirement. For many people, every little bit of return helps and it doesn’t make sense statistically to start increasing their allocation to bonds when the investor is so far from retirement. If their risk tolerance is such that bonds are appropriate, that is obviously different.
A Real Life Example
Let’s say you're ten years from retirement and are an aggressive investor. You’re looking at about a 30-year total span of time. About ten more years of work and then 20 years of retirement. We can break this down into six-, five-year chunks.
Some of your money will be used in ten to 15 years. Stocks had positive returns 94% of the time. So, some allocation to stocks seems appropriate. However, a positive return from stocks isn’t guaranteed so some money in bonds and cash is also sound. The next five-year chunk is about 15 to 20 years from now. Not quite long enough to make stocks a no-brainer. For investors that are more aggressive, we wouldn’t argue with all stocks for this allocation. For investors that are more conservative, keeping some money in bonds would still be wise. For the rest of the portfolio that won’t be touched for 20 or more years, there is not much of a financial argument for bonds or cash. If your personal risk tolerance is low, then of course that changes things, but assuming you can handle the fluctuations of the stock market, stocks make economic sense for this portion of the portfolio.
You end up with a portfolio that might be 50% stocks and 50% bonds for the first chunk, 30% bonds and 70% stocks for the second chunk, and all stocks for the last chunks. This would give you a blended asset allocation of about 13% bonds and 87% stocks. Keep in mind this is for a very aggressive investor. This is essentially as aggressive a portfolio as you would want to have given your retirement time line. Many investors will be more conservative and want to back off this allocation. But even given that we can see just how far away it is from Vanguard target allocation. At ten years from retirement, Vanguard is allocating approximately 30% to bonds in their funds.
In general, the conventional wisdom regarding asset allocation near or in retirement seems to ignore the fact that large portions of investors' money won’t be touched for many years. With that fact in mind, more aggressive asset allocations can be a good fit for more aggressive investors. Asset allocation is a highly personalized thing that depends on many variables so it’s impossible for Vanguard to make a one size fits all target retirement fund. Our point isn’t that Vanguard is bad or “wrong” just that the drumbeat of “you must include lots of bonds and cash when you get close to retirement” isn’t supported by historical return data. Instead, investors should feel free to include more stocks than is usually recommended in generic allocations if it’s a good fit for them personally.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We frequently include Vanguard target date funds in 401(k) accounts we advise.