How Much Stock Should You Hold in Retirement?
Income in retirement is far too important to be left to simple-minded calculations. We need to get off the path of simple-mindedness and actually look to figure this out right.
People’s situations differ quite a bit in retirement, and the circumstances surrounding the desirability of certain investments certainly do. We can’t just throw out percentages such as half in stocks and half in bonds or any other prescribed allotment without carefully considering the particular circumstances that apply to our situations.
We also need to avoid strongly preferring the lazy approach and this is way too important to want to be too lazy with. When we factor in all the effort that we put in to compile the amount of savings that we have, we can at least make a little effort to look to make this money work for us to do the work that we put into this more justice.
The first and most fundamental improvement that we need to implement is to completely toss the idea that it ever makes sense to try to adopt a blanket strategy whose goal is to use a fixed asset allocation that is not responsive at all to current market conditions. This is a terrible idea under any circumstances.
When we try to do this, this requires us to dial down our potential return to seek to manage the risk of this blanket approach, and people generally have no idea how limiting such an approach ends up being. If we seek to intentionally adopt a helpless strategy and then try to reduce the impact of this helplessness by diluting our potential returns, we’ve doomed ourselves to settle for a lot less return than we would have otherwise achieved.
Given that the great majority of retirees do not save up anywhere near enough to even make this approach provide a minimal level of comfort, we have slashed our expected value to the point of guaranteeing failure. If we require much better results than this approach is capable of delivering, we are not resigned to just accept this failure but instead need to at least look at how alternatives measure up, or dare to actually.
There are two factors to consider in designing an investing plan to take us through our retirement years, which are our own needs, as well as what the best way to tailor achieving these needs to the market conditions that present as the journey unfolds.
The common approach takes neither into consideration, as it treats us all like we are in the same situation, and then purposefully ignores what is going on in the markets, which is by far the bigger mistake of the two. If conditions are not suitable for our strategy, we do not adapt, we just take the punishment and perhaps look to reduce it a little by becoming even more conservative, and carry over this over-conservatism into periods where this is a very bad idea.
To Perceive Truth and Clarity, You Have to Look for It
We are going to need to take a fresh look at how people manage their finances in retirement, and especially subject current ideas to an honest evaluation. This is something that we do not even engage in normally, instead preferring to work within the parameters of the prevailing view which both exposes us to too much risk in the bad times and chokes off our potential when times are good.
The first thing that needs to go is the idea that there is an optimal asset class distribution for all seasons. If we cannot bear the risk of a certain fixed strategy like this because it is designed for those with a longer time horizon than we have, the buy and hold approach to stocks for instance, just looking to water down this approach by allocating a certain percentage to bonds isn’t the only alternative nor is it even a good one.
On our site, we always preach that we need to look at these two markets separately, and be in stocks when it makes sense to, be in bonds when it makes sense to, and be in something else, even cash, when it makes sense to.
This is not necessarily an all-or-nothing thing, but it might end up being, and another notion that is important to cast off is the idea that there is floor involved here where we should be keeping a certain percentage of our assets in a given class at all times, which requires us to ignore risk to a certain degree, which we do not want to be doing.
The blanket approach assumes that there not only is a floor here but this is not subject at all to market conditions but instead on age. We don’t want to assume that it is wise to have any of our money in an asset that is not performing well and is not expected to for a while, and this includes both stocks and bonds. Bonds can perform terribly as well and putting your money in bonds under these circumstances is always a mistake apart from anything else.
Looking at bond allocations is actually a good place to start our journey, and we need to start by asking ourselves when it would be preferable to have our money in bonds instead of in stocks or in cash. The only sensible answer to this is when doing so would improve the performance of our portfolio, which requires not only a positive expectancy with our bond positions but one that is also preferable to what is being offered by the other two asset classes.
If stocks are in a downward phase, and bonds are in an upward phase, that’s the time to be in bonds, and it is actually the only time. If stocks are doing better than bonds, it does not make sense to be in bonds. If the outlook for bond prices is negative, as it is right now, it does not make sense to be in bonds, period.
This is a far cry from the traditional approach, but they want us to have our money in something that has a negative expectation. This is not justified, and reasoning such as wanting to lose less if stocks turn from positive to negative does not count, because this is not a good way at all to manage stock market risk.
We are looking to hedge risks that have not manifested yet with a means that will dilute our profits and actually has us choosing something that is expected to lose money over something that is expected to make money. This is completely foolish no matter how you slice it.
If we are being true to our pursuit of the maximization of our risk-return ratio, we need to limit our bond exposure to when they truly are a competing asset, not use them to try to fend off monsters under the bed that we can just run away from if the need arises. This is the biggest mistake that investors make and is an especially bad one in retirement.
A One Size Fits All Approach to Investing is Based Upon Ignorance
The average investor proportions 40% of their portfolio in bonds, which goes up to 50% in retirement. People do not even question such things much, and when they do, it’s a matter of looking to play around with the percentages, never really wondering if there might be a better way than just tying our hands behind our backs in a certain fashion and then being helpless to act when desirable.
The optimal percentage for anyone right now, regardless of their situation, is not to be holding any of their portfolio in bonds right now, unless we intentionally want to harm ourselves. There are situations where being in bonds is a good idea, but this is especially not the case now, and bonds may not turn from their current bearish outlook to bullish anytime soon.
What we will need at a minimum is the expected continued selloff to bottom out and start to rebound, with enough room being created that we may expect to see their value move in our favor to make them preferable enough over cash. We also need to see the stock market struggle enough to produce a negative expected value, where we want to be in something else, and then see bonds win out among the alternatives.
When bonds project negative expectations, they lose out to cash every time, although we can be tricked into doing this anyway if we aren’t paying attention to the store. People generally don’t have much of an idea nor care where bonds are headed, they just do what they are told and add and hold them.
We’re not going to be in bonds all that much under this direction, unless we get a bear market with stocks that is, and being in bonds at all during bull stock markets isn’t just not optimal, it’s a crazy idea. The difference in returns between stocks and bonds is much more significant than we realize, and we’re supposed to be shooting for higher and not lower returns, although you would never know it by looking at the way almost everyone invests.
As far as considerations related to our own situation goes, there is an optimal path that exists apart from any of these considerations, but if we need to increase our returns to be OK, as is the case with just about everyone, it is even more important to seek the proper path that will best deliver what we need.
We might think that someone who is 80 years old has so little time left to make it too risky to hold stocks, but this is only the case if we are prescribing a brainless approach that ignores risk altogether and chooses to become exposed to it in full measure instead. This is a very bad idea indeed.
However, provided that our friend is of sound mind and willing to use it, which would actually make him or her stand out from the crowd pretty notably given the degree of unsoundness that people demonstrate generally, he or she could simply manage this risk by refusing to be exposed to the excessive amounts of it that we worry that a tied-up approach would bring.
Just like there is a time and place to be in bonds, when the conditions are right and only when they are right, there is a time and a place to be in stocks as well. Like with bonds, this does not mean being in them all the time, it means holding them when conditions are favorable and being out when they are not.
What retirees need to really realize is that we invest with a view toward making a profit, and we should not be letting ourselves being ruled by either fear or ignorance in the pursuit of this goal. This is no time to be lazy and want to just put our money in certain things and then just sit back and do nothing.
There are some who may be able to do that, to choose the wrong path and have enough resources to ride out anything that comes along and still be fine, but if we want to do that, we should be putting our money in annuities or CDs and not expose ourselves to risk that we do not want to take on.
This is not to say that under these circumstances this is the best approach or even a good one, but placing what end up being random investments and crossing our fingers is never wise. We may not need the extra money but we at least could seek it out instead of essentially engaging in an investing strategy that is not even rational. The fact that so many others are acting irrationally as well should not inspire us.
The main appeal for blanket asset allocation is supposed to be to allow us to manage risk better, but what this ends up doing overall is both choking our potential gains and not providing the benefit of better risk management that is supposed to be the benefit that offsets all the potential profit we choose to walk away from as the price for this.
We need to well forget about any notion that has us with a fixed asset allocation and instead look to tailor this allocation to the circumstances that we are trying to manage. The only sensible answer to the question of what percentage of our portfolio that we should have in stocks and bonds in retirement is that this depends on what is going on with these investments.
At the present time, this means 100% in stocks, without exception, at least if we dare to seek to be sensible. This might be one of the easiest times ever to decide this, as we have a bullish stock market and a bearish looking bond market. This is not even subject to debate or preference as it all just comes down to keeping your money in something only when it has a positive expectation.
If and when the time comes to exit stocks, where the outlook actually changes to bearish, then and only then should we be looking to bonds as an alternative, and only then when bonds actually are trending upward in price. We are managing the risk this way quite well indeed, by keeping our eyes on the road and adapting to changing conditions as we travel down it, and this allows us to be in when we should be in and out when we should be out, which is the only way that makes any sense.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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