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Asset allocation in Retirement

A different view
A June 2011 paper published by the Putnam Institute (Putnam Investments) called "Optimal asset allocation in retirement: A downside risk perspective" by W. Van Harlow (Download from
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lower part center column) suggests that an equity allocation of about 70% at age 65 as recommended by conventional wisdom is much too risky. The paper suggests that equities should make up < 25% of the portfolio.
Note that he uses withdrawal rates of 6-8% which is much higher than the 3-4% that convention wisdom suggests for persons planning to live 30 plus years in retirement.
May be convention wisdom is the wrong phrase but it conveyed what I want it to
Comments
Reply to
Avrum Lapin
I find it suspect that a 65 yr old man can draw 6% and have a .20% risk of failure. Conventional wisdom, as you say, says 4% is the number and the risk still greater than zero.
Reply to
JoeTaxpayer
I also wonder where you can get bond investments with 3% real return and cash investments with 1% real return. How long will it be before these returns become available? And can we say that bond and cash investments really are less risky than equities when you consider the possibility of a return of high inflation?
Dave 
Reply to
Dave Dodson
lower part center column) suggests
I think asset allocation needs to be driven by investment goals and risk tolerance. A 65 year old man can expect to live about 20 years. If a person can tolerate market risk and needs to grow his assets, it is reasonable to have an aggressive asset allocation. However he should have a 5 years of funding in bonds or cash; for a 5% withdrawal rate, that means about 25% of his portfolio.
I like to think that 8% portfolio growth will cover 5% withdrawal and 3% inflation. The good news is that for the last 5 years inflation has been low and my portfolio has not lost 15% of its purchasing power.
Frank
Reply to
FranksPlace2
I always thought conventional wisdom on this topic was much more conservative. E.g. "subtract your age from 100, and that should be your percentage allocation to stocks in your portfolio." See
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For similar statements on bond allocation as a function of age, google on {conventional wisdom bond allocation age}.
Reply to
Elle
Here's an article discussing both the Putnam paper and a similar report from the GAO:
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Note that a quick check on immediateannuities.com suggests that a 65 year old man can buy a single life fixed annuity (not inflation adjusted) right now with a payout yield of about 7.5%
A portfolio built with about 75% in such annuities and 25% in a conservative equity portfolio (itself with a 2% div yield) generates about a current 6% overall yield and that equity stake should go a long way towards keeping some long term inflation protection in there.
It gets messier if there are two people living off the nest egg (annuity pays a lot less if it's a second-to-die).
--
David S. Meyers, CFP®
http://www.MeyersMoney.com
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Reply to
David S Meyers CFP
In article ,
(100 - your age) in equities was certainly conventional wisdom up until about 1990 when planners started to use the assumptions behind Modern Portfolio Theory and Monte Carlo simulations to estimate the risk of outliving your money. Many advisors (including John Bogle) still believe in (100 - your age) in equities.
(100-your age) in equities was at best a seat of the pants estimate. My problem with (100-your age) in equities is that we are living a lot longer than we used to and so your money has to last a lot longer. Also we can no longer assume that our kids are going to take us in and so we are going to have to hire help. Note that some advisors have moved to (120 - your age) in equities
I also have problems with some of the assumptions in Modern Portfolio Theory a) the standard deviations (risk) associated with the asset classes will not change b) the correlation between asset classes will not change c) the number of years used is insufficient or alternately is too many d) reversion to the mean may not occur in our remaining years. e) that normal (Gaussian) distributions do not apply market data (Black Swans) f) that we really have no idea of our risk tolerance - Bill Gates can probably still make his house payments if his investments drop 90%, I would definitely have problems. But Bill and I may feel equally upset (emotionally) if our investments drop 10%
I posted my original note because the Putnam report was so different from current writings.
Reply to
Avrum Lapin
lower part center column) suggests
Unless I am missing something here, it seems there are two big factors that would modify these calculations and the degree of risk that could be tolerated in making withdrawals: First, whether or not there is a company pension in place (in addition to Social Security benefits) and, second, home ownership. I should think both would have a huge impact on what other assets need be converted to cash and withdrawn. There should not be nearly as much risk in having equity investments with a substantial pension in place and no need to pay rent.
Reply to
Don

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