Why Stocks, Not Bonds, Assure Less Risk in Retirement
Conventional wisdom about how to invest for retirement can be misleading.
May 20, 2014— -- Sometimes, what everyone thought was right turns out to be flat wrong.
Classic personal finance “wisdom” holds that as you get older, you should have less and less money in stocks and more in bonds to reduce risk of loss from down stock markets as you head into retirement.
But now, two authoritative studies show that this thinking is as wrong as an overcoat in the tropics. It turns out that as you approach retirement, you should have more and more of your total investment portfolio in stocks — as opposed to bonds — because the superior returns they will likely deliver reduce the risk that you will outlive your money during retirement.
A definitive study by Rob Brown, Ph.D., chief investment strategist for United Capital Financial Advisors, demonstrates that if your portfolio is 100 percent in stocks, the chances that you will run out of money during retirement are about half as great as with a portfolio that is 50 percent in stocks and 50 percent in bonds. The study, published in Financial Advisor magazine, found that the faster you withdraw cash from your nest egg to pay expenses during retirement (the withdrawal rate), the more you need to be in stocks.
And a comprehensive study of global stock returns by Morningstar, released this year, found that stocks are actually the safest type of investment. The study looked at 90 years of data from 20 countries.
Unaware of the actual benefits of having more in stocks and less in bonds, individual investors burned by the market meltdown of 2008-09 are now willing to take on what they may mistakenly think is more risk by increasing their retirement investment in stocks to take advantage of the current bull market. Many of these individuals doubtless are deviating from their planned asset allocation by having too large a slice of their total portfolios in stocks. Ironically, they are doing the right thing for the wrong reason.
The reason many of these investors will benefit in the long and the short term is that they’re deviating from decades-old advice that the studies show to be backwards. For decades, asset allocations recommended by the financial services industry have called for a formulaic proportion of assets in stocks — one that decreases significantly as investors go through middle age. It goes like this: Subtract your age from 100, and that number is the percentage of your total portfolio value that you should have in stocks, with the remainder in bonds. If you’re 30, the percentage in stocks should be 70 percent. If you’re 70, it’s 30 percent.
Now that people are living longer, advocates of this formulaic approach recommend subtracting your age from 110 or 120, but this isn’t much better. It still doesn’t result in an allocation to stocks great enough to assure that your nest egg will last through your retirement. Even back in the day when bond yields were good, using this rigid formula was a bad idea because it overlooked market fluctuations. Now that bonds are paying extremely low rates and inflation has begun to creep upward, it makes even less sense.
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