Recent articles by Bernstein Wealth Management [pdf] and Kiplinger’s Personal Finance suggest that as we continue to live longer lives, this should increase the percentage of our portfolios that we devote to stocks.
Living Longer…
A 2000 study by the Society of Actuaries states that a male who reaches age 65 has a 50% chance of living beyond age 85 and a 25% chance of living beyond 92. Women can expect to live two to three years longer than men. More importantly for couples, you are now looking at a 50% chance of one of you living beyond 92!
Means Some Potential Changes
Bernstein then ran some Monte-Carlo simulations using historical data (for what years, I couldn’t tell) to “help quantify the impact of alternative allocation and spending decisions over varying time periods and markets.” The basic scenario was a couple who retired at 65. The variables were how aggressive the portfolio was (20%-100% in stocks), and how much you withdraw from the portfolio each year (2-7%). Here are two summarizing charts and some of their findings:
- If you’re going to spend a relatively high percentage like 5% of your portfolio, it is important to keep your stock percentage at least at 60%. But, increasing it to all the way 100% doesn’t help much, and increases the downside in a bear market.
- At a low spending rate, like 3%, then your stock percentage doesn’t matter that much either way.
- Although spending and allocation are both critical factors, the former tends to exert a more powerful influence. Simply working a bit longer in order to delay spending can increase your success rate significantly.
Conclusions
Taking into account these findings, the Bernstein paper concludes that although bonds are a traditional safe-haven for retirees, their increased longevity make the growth from stocks important throughout one’s lifetime. They suggest that a proper compromise between these factors is a portfolio of 60% stocks and 40% bonds, along with a 4% spending rate. This gives the couple an 85% chance of having their money last till death.
Glassman of Kiplinger also makes his own suggestions:
Bernstein emphasizes that individual clients’ needs differ. Certainly, but based on this report and other research, I have decided to raise my suggested quick-and-dirty stock allocations for retirement accounts this way: If you’re under 40, there’s no reason not to own a 100%-stock portfolio. Between ages 40 and 60, you can move to an 80-20 stock-bond ratio. Between age 60 and retirement, shift to keep at least 60%, and in most cases closer to 70%, in stocks.
This is much more aggressive than almost all the Lifecycle or Target-dated Funds (see here for a comparison between Vanguard and T. Rowe Price Target Retirement funds.)
My concern would be that with so much in stocks, when people “fail”, they fail by a lot, whereas with bonds it might be easier to compensate for a slow stock market by working part-time. I’m undecided as to if this study will cause me to make any changes.
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Good article,
It makes me think of Paul Merriman at FundAdvice.com. He recommends something similar to this. However, his portfolios all had a 40% bond safety net unless the person was 25. It makes me curious what the actual returns were in this situation.
I agree with the idea of not keeping any bonds in your portfolio, until 10-15 years from when you will need to start drawing from your funds. I think I read somewhere that bonds have never beaten stocks over any 10 year period, of course with the Boomers retiring who knows if that will hold, but historically stocks have been far less risky long-term investments than bonds.
If the Baby Boomers just about to retire (this year the oldest ones are 58? ) and they are probably following this advice, then younger people should definitely stay in stocks and ‘ride the wave’, IMO. As overvalued as it may be, the market should probably hit $20K in the next 10-15 years. So why not?
Glassman of the Down 36,000 fame? I don’t think he has much creditability. I guess he’s still hoping and waiting for Dow 36,000.
Thanks Jonathan, I enjoy reading your posts… Minor point: I think the probability of at least one partner living beyond 92 is actually 44% (i.e. the inverse of the probability of both passing away before 92: 1 – .75*.75).
What I would love to find out is if people are actually really running out of money if they followed professional investment advice. Are people who did everything they were supposed to do still living in poverty? Are their healthcare costs really outstripping their savings? And I don’t mean people who are in their 50s and 60s because they are all over the news, but folks who are, um, winding down, like in their 80s and 90s. Kind of a tough thing to research, but I am curious.
Yeah, there seem to be a few numbers missing here.
Like: “How much money do you have at death?”
B/c let’s face it, you don’t really need any when you’re gone. So when is the point at which you cash out for some form of term income and give away the rest?
If I’m 25 today and fully vested in stocks, when should I start splitting into the 80/20? Seems like sometime between 40 and 60, but what if the markets hit a 20-year drought when I’m 39 and I lose 80% of my stock value? I mean, the markets may recover by the time I’m sixty, but at that point I’m out 20 years of simple compounding interest.
And either way, haven’t most people on this board (other than myself) agreed with “efficient markent” and poo-pooed on “market timing”.
And what about sustainability? This model only works if inflation is relatively constant, but if 15 or 20% of the workforce exits in the same decade, then this won’t be the case. If it takes 25 to be socially productive and you only get to work for 40 years and THEN you live for 20 more years, how in the heck is this sustainable?
That whole model is based on people being “productive” for about half of their life! That’s 45 years of education/retirement and 40 years of productivity. How can you have 75% of the population doing this, how can you even have 50%? This whole retirement at 65 with no work model is exclusively the realm of the rich, nobody else is going to pull this off.
If too many people are “retired” and only half the population is generating income at any point, then isn’t the inflation rate is going to skyrocket and force the retirees back into work?
I’ll keep this study in mind for when I retire in the market which always performs at the past average.
“I?ll keep this study in mind for when I retire in the market which always performs at the past average.”
A proper Monte-Carlo simulation runs through all the scenarios, including the good and the bad, so it’s not just taking averages. However, it is based on historical performance.
I still think the hardest thing will be to stay in 100% stocks as sometime during the next 20-30 years there will inevitably be a time when bonds do great and stocks stagnate for an extended period of time.
“If you?re under 40, there?s no reason not to own a 100%-stock portfolio”
I cannot disagree more with this. There are many reasons, however first and foremost is that most folks just don’t have the stomach to “stay the course” and hold onto their 100% stock portfolio during a prolonged bear market.
Imagine a 39 year old investor who has been diligently saving for retirement for say almost 20 years, and has a retirement savings of $500K. Then along comes something like the ’73-’74 bear market, and he/she loses nearly half his retirement savings.
All but the most dedicated (and educated) investors are going to have a hard time coping with that loss and sticking to their plan. If they abandon it and sell those stocks (for “safer” investments) after the market tanks, then they “lock in” those losses to their portfolio’s detriment.
Sure, bonds are “expected” to produce less return than equities, but (1) no one knows that’s for certain going forward and (2) bonds provide the cushion to soften the blow of unexpected downturns in the market.
In any case, I think that is very dangerous advice to give to anything less than an experienced/educated investor. I think advisors like Rick Ferri (author of All About Asset Allocation) recommend no LESS than 20% bonds, regardless of age.
It’s been shown time and time again that just a small sliver of bond allocation results in a significant reduction in risk with only a minor reduction in return. That’s a tradeoff I’m willing to take.
Chris
I hear Chris and I’d actually like to take it one further:
“All but the most dedicated (and educated) investors are going to have a hard time coping with that loss and sticking to their plan”
Given that most people have finite amounts of investable income, they’ll also need the financial stability to weather the whole storm. If you get laid off in bear market and your safety net evaporates (say your SO gets sick), then you’ll have to go pilfer from your investments, which means that you’ll have to cash out stocks at a loss. If you have at least some bonds, then you’ll be able to take money from there first and you won’t be taking it at a loss.
I somewhat disagree
There are some people who plan on retiring in their 50’s and having a portfolio of 80% stocks is just nuts.
I can agree that maybe somebody shouldn’t go lower than 60% stocks, but I will disagree that a person close to retirement should consider a portfolio of 80% stocks.
Even Paul Merriam isn’t that nuts, he understands that a 60/40 portfolio will give you about 88% of the returns of 100% stock portfolio with about 55% less risk.
It could take you 10 years to recover from a crash, which seems like the typical thing. When the market is doing well you only read articles about how we should be in stocks, when the market is bad they warn you how you need bonds. When real estate is doing good, you can’t go wrong with real estate, when it’s doing bad they told you that there was a bubble.
If you have 10 years to retire and your 80% stocks, good luck to you. hopefully your going to be able to supplement your income some other way.
I wanted to make a few comments.
First, A monte carlo simulation simlulates what the future might bring using a probabilistic model. This is done hundreds of times to simulate the various possible outcomes. Then the total number of successful outcomes is divided by the total runs to get a probability of sucess. This analysis is only as good as the model. Many times the probabilty model (such as a gaussian one) does not do a very good job of representing the tails of the distribution (i.e. catastropic conditions, market crashes). The tails can have significant impact. The book “The Black Swan” approaches this idea.
Second, even if the analysis is “right on the money” and shows a 89% probability of having enough money, if you end up in the other 11%, it still sucks.
Three, if you diligently save, you’ll be better off than most. 25% of those retired live only on Social Security.
“Second, even if the analysis is ?right on the money? and shows a 89% probability of having enough money, if you end up in the other 11%, it still sucks.
Three, if you diligently save, you?ll be better off than most. 25% of those retired live only on Social Security.”
Paul – I agree, put those two points together and I think the idea is that you won’t shrivel up and die if you’re in the 11% in such a scenario. Hardly anyone will just keep spending their 5% or whatever into the ground. Beforehand, you will be faced with a lower standard of living or working longer.
As you noted, the problem here is that all failure is the same. Being $1 short in your last year is considered as much a failure as running out with 20 years left. Clearly the former isn’t really a significant amount of failure.