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A recent study found that holding as little as 20 percent in stocks upon retirement, with the remainder in bonds, would result in a smoother ride during turbulent markets, and the money would last a few years longer. (Robert Neubecker/The New York Times) -- NO SALES; FOR EDITORIAL USE ONLY WITH STORY SLUGGED YOUR MONEY BY TARA SIEGEL BERNARD. ALL OTHER USE PROHIBITED.

Robert Neubecker • New York Times,

Increasing stocks not a bad strategy in retirement

  • Article by: TARA SIEGEL BERNARD
  • New York Times
  • September 21, 2013 - 4:30 PM

It’s the kind of advice people approaching retirement long to hear: You may not need to keep as much of your hard-earned savings in stocks.

Traditionally, retirees have been told to keep a significant slice — about 50 to 60 percent of their portfolio — in these risky assets, and that’s what many people do. Then they hope and pray that the stock market doesn’t plummet as it did in 2008 and 2009.

An intriguing new study found that holding as little as 20 percent in stocks upon retirement, with the rest in bonds, would result in a smoother ride during turbulent markets and that the money would last longer.

There is a catch. Retirees need to gradually buy stocks over time, but they don’t necessarily end up owning more than most retirees start with.

“There are a lot of retirees in serious trouble because they bailed entirely in late 2008 or early 2009 because they couldn’t get comfortable with the volatility of a traditional portfolio,” said Michael Kitces, director of research at the Pinnacle Advisory Group, who wrote the study with Wade Pfau, a professor of retirement income at the American College of Financial Services.

The approach in the study runs counter to the traditional advice, which suggests keeping a steady mix of stock and bond funds throughout retirement or slowly lowering the amount of stocks. More than half of target-date funds for people nearing or in retirement continue to reduce stocks over time, according to Morningstar.

Portfolios that started with about 20 to 40 percent in stocks at retirement, then gradually increased to about 50 or 60 percent, lasted longer than those with static mixes or those that shed stocks over time, according to the study.

The logic is that if you experience a bear market shortly after you stop working, you need to make withdrawals when the portfolio is down. You’re selling at the worst possible time. But if the market performs poorly later, say, in the second half of retirement, the damage to the portfolio is less severe because it had several decent years first. The sequence of your returns matters. “If you have a bad sequence of returns early in retirement, you would have a lower stock allocation when you are most vulnerable to losses,” Pfau said.

The second piece of this strategy involves slowly increasing your exposure to stocks. If a crash occurs in the early years after you retire, you will be buying stocks when they’re cheap. By the time the market recovers, you’ll have a bigger slice of your money in stocks again.

“It becomes a ‘heads you win, tails you don’t lose,’ situation,” Kitces said.

More specifically, the study looked at how different mixes of stocks and bonds would affect how long a retiree’s money would last if that person initially withdrew an inflation-adjusted 4 percent of total assets each year. For a person with $1 million in retirement assets, that would translate to a $40,000 withdrawal the first year; for someone with $500,000 in savings, the withdrawal would be $20,000.

They tested the different stock and bond allocations using a Monte Carlo analysis, which simulates thousands of situations to determine the odds of possible outcomes; they also analyzed how the different mixes would perform with three different sets of market returns after inflation.

Even in a worst case, they found that new retirees who start with 30 percent in stocks and slowly increase that allocation by 1 percentage point a year to 60 or 70 percent in stocks would be able to withdraw 4 percent of their portfolio for about 30 years. Someone who held 60 percent in stocks and 40 percent in bonds over 30 years would run out of money two years earlier, but also would have to endure a bumpier ride, the researchers said. (These results assume stocks will grow about 6.5 percent a year, on average and after inflation, while bonds will increase 2.4 percent).

The money didn’t last quite as long when stocks and bonds performed worse than they had historically (about 3.4 percent for stocks and 1.4 percent for bonds, after inflation). Using those assumptions, the portfolio runs dry after about 23 years. In this case, the portfolio that started with 20 percent in stocks and gradually rose to 50 percent lasted about two years longer than the one that held steady at 60 percent in stocks and 40 percent in bonds.

All of these results represent what would happen if things went wrong.

According to the analysis, most of the time, the portfolio would have lasted longer than 30 years — sometimes significantly longer. But about 5 percent of the time, the portfolios ran out of money even earlier than in the situations sketched above. In those cases, the retirees would have had to make adjustments, such as cutting back spending, to stay on course.

If you are lucky enough to retire when the markets perform relatively well — and you hold less in stocks in the early days of your retirement — you obviously will earn a bit less.

The hardest part of this strategy may be sticking with it. If the market is on the decline, you need to continue to buy stocks even if it doesn’t feel right. This could become even less palatable as you age.

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