While the majority of Americans aspire to retire comfortably, and on their own terms, survey after survey shows this is becoming far from a reality.
Last year, consulting firm Towers Watson issued its latest Global Benefit Attitudes Study, which examined Americans' financial security and retirement planning preparedness. It found that approximately four in 10 workers planned to delay their retirement, with close to half (44%) of the delayers suggesting their retirement date could be five or more years beyond the traditional date workers have historically hung up their coats, age 65. In fact, a 2013 Towers Watson survey showed that a full 7% of respondents never planned to retire.
In an ideal world, never retiring sounds great if you're doing what you love. But we rarely find ourselves in ideal situations. Emergencies, our health, and even the vitality of the companies we work for sometimes threaten our ability to work into our golden years. Additionally, with all industries becoming more high-tech, it's increasingly difficult for senior citizens to land a job.
Stay the course, and all will be well. Right?
As such, we've been taught for decades upon decades that the best course of action for investors is to save as much as they can while working, invest aggressively when they're young, and slowly tone down the aggressiveness as you head into retirement. This common strategy involves Americans taking advantage of their ability to take risks while young, while moving to more of a capital preservation/income strategy during their later years.
Another strategy you've probably heard about is the age-based asset allocation. In other words, if you're 65 years old, 65% of your investments should be in bonds or fixed-income assets. As your age increases, so does your percentage of fixed-income (thus safer) holdings.
But, are these strategies all wet? According to a recent article published in the Journal of Financial Planning by authors W ade Pfau and Michael Kitces, your entire way of thinking about investing for retirement needs to be completely rejiggered.
Is it time to reconfigure your investing strategy in retirement?
While a quick read of Pfau's and Kitces' work might leave you scratching your head a bit, I can quickly summarize the thesis of their discussion of retirement glide paths, or in layman's terms, what they believe should be the proper allocation of stocks and bonds in Americans' investment portfolios.
The authors studied a number of models, but they focused on a series that suggested an individual would retire and need their money to last for 30 years. These models examined asset allocations including a portfolio that began with 60% of assets in equities just prior to retirement (e.g., stocks) and ended at 30% some 30 years later (essentially a 1% step down each year); a portfolio that began and ended with 60% in equities (i.e., no change over 30 years); and a portfolio that stepped up from an equity allocation of 30% to 60% by the end of the 30 years (a 1% step up per year). Any guesses which model proved the best?
Based on the authors' findings, the step-up method was by far the most successful, reducing a person's chances of running out of money in retirement, and also reducing the magnitude of their failures. In simpler terms, the authors are suggesting an inverted U-shape asset allocation during one's lifetime, whereby young adults begin with a high allocation of equities and a low allocation of bonds and slowly build up the percentage of their portfolio devoted to bonds throughout their lifetime, leading to the point at which they retire. However, during retirement the authors suggest scaling back on bonds and once again building up your exposure to equities (stocks).
What's the rationale? The authors opine that a retirees' cash drawdown, compounded with the rate of inflation, won't allow them to adequately replenish their cash if they're heavily invested in bonds. This is something you've likely dealt with firsthand over the past six years as the federal funds target has been pegged at historic lows, causing CD and bond rates to plunge. However, the authors believe a higher bond allocation just prior to retirement makes sense given that investors need to be conservative with their money right before retirement and shouldn't make wild gambles in the stock market.
On the other hand, the authors suggest that increasing exposure to stocks each year during retirement allows individuals the opportunity to outpace inflation, as well as to let their nest egg replenish itself, potentially even after taking distributions.
Does this thesis make sense?
To some extent I agree with the authors' findings, with one major exception.
I believe the study's findings are extremely pertinent for baby boomers, who were crushed by the Great Recession. Some boomers were far too scared to hang on to their investments through the depths of the downturn and sought shelter in bonds, CDs, or money market accounts. Long story short, many of these boomers never recouped their losses, even when the stock market found its footing again.
Baby boomers, even with their possible distrust of the stock market following 2007-2009, would be the perfect candidates for Pfau's and Kitces' model of increasing their exposure to equities with each passing year. As a whole, I suspect boomers will probably need to be more aggressive with their investments than previous generations to ensure they don't run out of money in retirement. As such, a step up in stock holding during retirement makes sense to me for this crowd.
Additionally, I tend to follow the logic of the authors in that maintaining a strong presence in equities is important during retirement. While there's plenty of room for income investments such as bonds and CDs in your retirement portfolio, they're not always going to give you a chance to outpace inflation.
But one area where I'd respectfully disagree, or should I say remain somewhat skeptical, is the authors' suggestion that pre-retirees boost their bond holdings just before retirement. While this was admittedly the worst recession Americans had seen in seven decades, this is exactly what the baby boomers did right before they retired, and it caused them to miss out on substantial gains when the stock market rebounded. Now, I'm not in any way advocating that this was an issue of "market timing," which simply can't be done with any accuracy over the long run. Instead, I'm suggesting more of a constant equity holding over the extended term to take advantage of the benefits of time and compounding that the market offers.
The stock market has proven time and again to be the best creator of wealth, with an historical return rate of about 8%. That easily trumps the average rate of inflation over the past 100 years of roughly 3.5%. You'll likely struggle to find other investments that so handily trounce inflation, but you'll sometimes need to exert patience to succeed. In short, there will be bumps in the road, but the stay-the-course strategy still seems to hold the most water in my book.
What do you think? Sound off with your views in the comments section below.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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