Between longer life and a seemingly never-ending bull market, you might be tempted to invest more heavily in: shares during retirement than the rule “110 minus your age” dictates. But new research from Dimensional Fund Advisers shows why retirees need to be more conservative when it comes to too much equity exposure in their pension funds. These findings may deter retirement savers from the benefits of riskier investing. Swinging in front of the fences can be tempting, but a solid single, without the risk of a strikeout, can produce a similar result.
The Dimensional data, based on 100,000 simulations, has shown that an income-driven asset allocation Consisting of only 25% equities offers a comparable retirement income to a wealth-oriented portfolio weighing 50% in equities, but manages longevity risk more effectively.
Investing income versus wealth
Wealth investments can provide greater returns, but an income-oriented approach that uses liability-driven investments better make sure that a retiree has enough money to last the rest of his life.
Mathieu Pellerin’s research found that a 65-year-old with wealth allocation equally split between stocks and short-term nominal bonds has a 30% chance of running out of money during a 30-year retirement. Meanwhile, a retiree with an income-oriented portfolio (25% stocks and 75% inflation-protected bonds) has only a 20% chance of going without retirement in the same period.
“High equity exposure in retirement increases portfolio variability, increasing both the likelihood of running out of assets and the likelihood of leaving a large legacy,” Pellerin wrote:.
The income-oriented approach not only protects better against longevity risk, but also provides a retirement income comparable to its wealth-oriented counterpart. Assuming an investor between the ages of 25 and 65 contributes $12,500 to their retirement fund each year, both slides would bring in more than $1.3 million.
While the wealth-oriented asset allocation yields an average nest of $1,376,458, the income-oriented approach is not far behind, averaging $1,336,764, according to the projections.
110 min age rule
The 110 min age rule is a guideline often used to determine an appropriate allocation of retirement assets based on a person’s age. Subtracting your age from 110 normally leaves you with an appropriate share percentage for your portfolio. More conservative investors can subtract their age from 100, while more aggressive investors can use 120.
According to this rule of thumb, a 65-year-old retiree with a moderate risk profile 45% of its assets would be allocated to equities and the rest to fixed income securities. An aggressive investor may have up to 55% equity exposure. But the Dimensional research suggests the rule could inflate a retiree’s equity exposure. A portfolio mainly divided among inflation-protected bonds and only 25% stocks have a better chance of keeping a retiree well into their 90s, while generating enough income to cover annual expenses.
Retirees and those nearing retirement may be tempted to increase their equity exposure to take advantage of upward trends in the market. However, research by Dimensional Fund Advisors shows that an income-oriented portfolio of 25% equity and 75% liability-driven investments offers comparable income to an asset-oriented portfolio with higher equity exposure and higher longevity risk.
Pension Saving Tips
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SmartAsset is free asset allocation calculator can be a welcome resource if you want to rebalance your portfolio or know what percentage you want to invest in stocks, bonds, and cash.
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