With the S&P 500 SPX up about 20% on the year and bonds lagging, it can be tempting to forget about safety and try to catch the upward wave.
If you’re trying to decide on the best portfolio ratio for right now — whether you’re 25, 40 or even 60 — this isn’t the most consequential decision you can make with your investments, because you still have a long time ahead to make adjustments. But if you’re already retired, it’s one of the most important things you have to decide, and even more so if you’re newly retired. The liftoff of your retirement path is extremely important, and then you have to keep track of where you go from there.
There’s also a theory that reverses that: One where you start out more cautious in the early years of retirement when your returns matter most, and then get more aggressive as you age. The theory is that as your nest egg gets smaller, you have to work it harder. It’s an all-in scenario, one that is still attracting adherents as market conditions swing toward high equity returns and still-low interest rates on fixed income. It also works for wealthier retirees who are investing funds they intend to pass on to heirs or charity.
“I still think the idea holds up,” said Wade Pfau, one of the retirement experts, along with Michael Kitces, who have published research on what they called “rising equity glide paths.”
Retirement expert David Blanchett tested more than 6,000 scenarios to see which glide path was best nearly 10 years ago for a research paper. The differences among the different options weren’t staggering, but significant enough to declare a clear winner: the traditional declining equity glide path.
That said, Blanchett, who is now head of retirement research for PGIM DC Solutions, stressed that glide paths are dynamic. You don’t just pick one path at the beginning of retirement and cling to it for dear life. “Retirement is a moving process, and the key is for your strategy right now to be reasonable given your situation,” Blanchett said in an interview with MarketWatch.
Take those in the FIRE movement who are trying to build up a big nest egg and retire early. If you roll the dice at 45 and it doesn’t work out, you can probably go back to work. If you can’t, or you’re older and that isn’t an option, then you can adjust your spending rate.
“I don’t mind FIRE folks being aggressive; they have other levers,” said Blanchett. “But if you’re in retirement and that’s your only nest egg, that’s when I get concerned about taking on risk.”
For Pfau, the rising equity scenario makes sense for retirees of all types because you take on the least amount of risk early in retirement, when the stakes are the highest. If you have low returns in the beginning, you can never really make up for that — it’s what’s called sequence-of-returns risk. If you wait to get more aggressive in the second half of retirement, you will not miss out on any equity gains that happen in those years.
“That resonates with some people, and for others it seems like a terrible idea,” said Pfau. “I’m not pushing the idea on anyone, but if it sounds good to you, it can help.”
No matter which glide path you pick, bonds are considered the safe side of that equation. But which bonds? It can be tricky to balance risk even within the fixed-income arena — which can include cash, money markets, CDs, pensions, annuities, Series I bonds, Treasury bonds and corporate bonds, plus Social Security.
Pfau pointed out that the reverse glide path actually mimics the role Social Security plays in a retiree’s overall net worth as an annuity on the fixed-income side. “The present value of your Social Security actually declines over time,” he noted. Your government benefit might start out having a present value of $1 million when you start retirement, but as you receive your benefits, the total left to come is much less. If you count that as part of your bond allocation, over time your portfolio ratio will shift naturally in favor of equities without you even noticing it.
While this is happening, you have to choose the rest of your safe allocation. In today’s rate environment, what is most important is beating inflation. Advisers like Blanchett and Pfau both find Series I bonds to be problematic because of the purchase cap of $10,000 per year per person and because the rates are not competitive at the moment — the latest 6-month I-bond rate was just announced as 3.11%, starting Nov. 1.
“You want inflation protection, and for that I look at TIPS,” said Pfau. “Who knows what they will do in the future, but for now, if you can lock in some spending goals in today’s environment, laddering TIPS is a good option.”
Blanchett agreed. “A year ago everyone was talking about I bonds, but today less so,” he said. “It’s a function of interest rates and inflation. You can’t put that much into them and you can’t reallocate them the way you can with other types of investment.”
Blanchett also prefers TIPS, plus corporate bonds. “Hopefully, you have a portfolio of $500,000 or more, so you can divvy up that bond allocation,” he said. “Either a fund can do that for you, or you’re buying the pieces yourself.”
The bottom line for both Pfau and Blanchett is that no matter what glide path you pick, you have to keep paying attention to it and making adjustments. The biggest determinant of success is how much you have saved. If you have a healthy nest egg, you’re going to do fine no matter which path you pick. But if you’re underfunded, you need to be very careful.
“You have to think about whether you want to save more, work longer or spend less,” said Pfau. “If you can’t consider those, then go for higher rates.”
But that, in the end, comes down to mindset. If you have a probability mindset, you can see that markets generally go up over time, and you can just kind of go for it. But “if you have more of a safety-first outlook, the answer is not to make a Hail Mary pass and hope for the best,” Pfau said.
“You can get well-thought-out answers on both sides of that,” he added. “There’s not just one way to approach it.”
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