In Retirement, Equities Should Rise

A rising equity glide path helps retirees sustain a greater income during their retirement years, a study suggests.

Wade D. Pfau, The American College, and Michael E. Kitces, Pinnacle Advisory Group, explored the issue of what is an appropriate default equity glide path for client portfolios during the retirement phase of the life cycle. They found rising equity glide paths in retirement—in which the portfolio starts out conservative and becomes more aggressive through the retirement time horizon—have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios.

According to the research report, generally, depending on the underlying assumptions, the optimal starting equity exposures are around 20% to 40% and they finish at around 40% to 80%.When modeled relative to the success of a 4% or 5% withdrawal rate in particular, the results varied depending on the details of the return assumptions and the target spending level. an initial allocation of only 30% in equities at retirement, rising to 80% by the end of retirement, actually provided the highest success.

The research implies the traditional approach of maintaining constant asset allocations in retirement to which the client is routinely rebalanced are actually far less than optimal. While such an approach is superior to decreasing equity exposure through retirement, the results of the study reveal the best solution may be to steadily increase equity exposure throughout retirement.

The findings are counterintuitive from the traditional perspective that equity exposure should decrease as the retiree’s time horizon decreases. The researchers explain that the success of a retirement scenario is heavily influenced by the sequence of returns. If the returns are good early, the retiree is so far ahead relative to the original goal, that a subsequent bear market in the second half of retirement has little impact, they contend. If the returns are bad in the first half of retirement, the portfolio is so stressed that the good returns that follow are crucial to carry the portfolio through to the end.

The research paper, “Reducing Retirement Risk with a Rising Equity Glide-Path,” can be downloaded from here.