New research may change retirement investment paradigm

A popular rule of thumb has held that the percentage of equities (stocks) you hold in your portfolio should get smaller as you age, especially when you are retired. While this seems to make sense, I contend that as long as you have a while to go before you die (my guess—you don’t have an exact date), you need to have a larger, static part of your portfolio in stocks to keep up with future inflation.

But now there are studies out that conflict with those two sentiments. Michael Kitces, a perennial favorite of mine (www.kitces.com), believes you should actually increase the amount of your portfolio that is invested in the stock market as time goes on.

Now, before you totally freak out, cash in your savings bonds, and start playing the market, let me explain what’s going on here.

The greatest danger of stocks in a retirement portfolio is a pronounced negative market event (translation: a really bad bear market) early in your retirement. There are a few main ways that investors handle this problem. The first is to have a decent amount of stocks, but to also have a bigger portfolio than will likely be needed so that if the drop happens they still have enough to live comfortably. We’ll call that one the aggressive strategy. The other is to reduce the amount of stocks so that the worst won’t happen to them, but to also have a bigger portfolio so that they still have enough to live comfortably even through their portfolio won’t grow all that much. We’ll call it the conservative strategy.

The new research indicates that if investors begin with lower stock allocations early in retirement and raise them as years go on, they will end up with a portfolio that can survive if the market suffers a “negative event” early. If the market doesn’t suffer early, the portfolio will not only survive, but thrive.

Why? Because early on, when you are most susceptible to a market drop, you will have fewer stocks exposed. Thus, if the market does drop, your portfolio will act like the one that uses a conservative strategy. Later, no matter if there was a drop or not, your portfolio will be more aggressive because you’ve been increasing your stock exposure as time went on, possibly helping you keep up with inflation.

Now, this research, while accurate, is just a start. Many more studies will need to be done before we have enough answers for a complete design. Questions like when do you start decreasing stock exposure ahead of retirement and at what rate? At what rate do you increase exposure after retirement? Do you change what happens late in retirement depending on whether a recession occurred in the early years?

While not ready for prime time, these kinds of research show that you don’t want to stop learning when it comes to your money. There may be a better answer than the one you first thought was best.

This article was published in the Wichita Falls Times Record News on July 7, 2014.