Investors often search for advice on their optimal portfolio asset allocation—a portfolio’s mix of stocks, bonds and other securities. However, that information may not be readily available, as it often depends on each individual’s investing goals. Much of the investing advice out there relies on common misperceptions that encourage retirees to follow potentially misguided strategies, such as investing primarily in low-yielding or income-generating securities, which may increase their risk of allocating too many of their funds into a few asset classes or possibly not achieving their long-term financial goals.
For investors approaching retirement, some advisers may suggest shifting retirement portfolios’ asset allocations away from equities and into fixed-income or lower-yielding investments. Some of these advisers recommend “target date” funds, which normally adjust their asset allocations from stocks to bonds or other securities over time, to investors planning for retirement.
But a “target date” or “age-based” approach to asset allocation isn’t always the best option, and some of those who advocate it are often perpetuating the common misconceptions about the proper asset allocation for retirees, which can include:
However, fixed-income—like all investments—come with their own set of risks, especially for retirees who allocate too much of their portfolios assets to them but require long-term portfolio growth. When establishing their asset allocation, retirees should take into consideration many factors, the first of which is the cost of retirement.
What costs will you incur when you are retired? Even the most thoughtful investor may overlook certain costs that will affect their retirement strategy and overall income needs.
For example, retirement is a time when many retirees start to travel extensively, pick up a hobby to occupy their time or have an active social life. Investors should consider these potential costs when retirement planning, as well as the costs they may incur to cover any education-related expenses of children or grandchildren.
Medical expenses generally grow with age as reliance on medical equipment, devices and prescriptions increase. Retirees should also factor in potential costs of in-home care, hospital visits and assisted living.
And don’t forget changes in the overall cost of living. No one can expect the prices they pay for everyday goods and services to remain static, which is why retirement income must at least keep pace with inflation. Investors who focus too much of their portfolio’s asset allocation in fixed-income or lower-yielding products risk the potential of losing purchasing power over time, forcing them to dip into their principal.
Since 1925, inflation has averaged 3% a year.i If that average inflation rate continues into the future, a person who currently requires $50,000 per year in income to fund their annual living expenses would need approximately $90,000 per year in 20 years, and about $120,000 in 30 years just to maintain the same purchasing power.
Many tout fixed-income investments as a steady stream of investment income during retirement, but fixed income is far from the only way to have steady income or cash flow from your portfolio. Fixed income can be useful for some retirees in certain situations, but it also has its own set of risks.
Fixed income instruments like bonds normally pay a fixed rate or coupon rate on an ongoing basis. But they only pay over a specified term, and if new bonds aren’t available at the same yield rate as the previous bonds, then a portfolio’s income may fall even though it maintains the same asset class allocation. We call this reinvestment risk—the potential that your future bond payments may have to be reinvested at a rate lower than your original investment.
There are other risks with fixed income as well, including default risk—the risk that the issuer could default and you might not get back your entire principal—and interest rate risk—the risk that interest rate changes reduce the value of your bonds.
The sum of all these factors is that retirees’ expenses often increase over time. When retirees allocate their retirement portfolios too heavily towards fixed-income and other lower-yielding investments, they may run the risk of not meeting their long-term investment goals. This situation applies especially to those retirees who require portfolio growth in retirement.
All these factors become more prominent the longer the investment time horizon. Unfortunately, investors often miscalculate how long their retirement investments and income may need to last. Specifically, investors tend to underestimate how long they will live. With advances in medicine and medical care, people are living longer on average. This means an investor who retires at age 60 could reasonably expect to live another 25 years or more, and their asset allocation for retirement should reflect that possibility.
Depending on their individual financial situations, retirees requiring portfolio growth should consider keeping a sufficient portion of their asset allocation for retirement in equities. Over 30-year time periods, a diversified equity portfolio shows higher returns and a lower standard deviation—meaning lower volatility—than a fixed-income portfolio.ii
And though many advocate for bonds’ steady coupon payments, investors with a diversified equity portfolio can often create similar cash flow by strategically selling off small portions of their portfolios—a practice we call “homegrown dividends.”
The ideal asset allocation for retirees can vary widely depending on each investor’s unique income requirements, investment time horizon and long-term financial goals. Fisher Investments can help retirees in many aspects of managing their retirement investments, from early stage retirement planning to ongoing portfolio management. Our team can help you:
At Fisher Investments, we can help you keep your investments aligned with your goals at every stage. This includes helping you stick to your strategies and remain disciplined through difficult markets as well as altering your investment strategies if your goals or investment objectives change. We do this by providing you with world-class client service and a dedicated investment professional. Contact Fisher Investments today to request a complimentary consultation and portfolio evaluation or read more in one of our guides.
i Source: Global Financial Data, as of 07/12/2017. Based on US BLS Consumer Price Index from 1925-2016.
ii Source: Global Financial Data, as of 01/04/2018. US 10-Year Government Bond Index, S&P 500 Total Return Index, average rate of return for rolling 30-year periods from 01/01/1926 to 12/31/2017. Standard deviation represents the degree of fluctuations in historical returns