Financial advice tends to focus on financial assets, and more specifically how those assets are allocated. However, other levers may be more important for most households, according to a new paper from the Center for Retirement Research at Boston College.
“Financial planning tools frequently highlight the asset allocation decision, suggesting that individuals have a lot to gain by adopting a more optimal allocation of stocks and bonds,” write Alicia Munnell, Natalia Sergeyevna Orlova and Anthony Webb. “In contrast, they are often silent on the benefits of other options, such as delaying retirement, controlling spending, or taking out a reverse mortgage.”
The typical 401(k)/IRA balance of households approaching retirement is less than $100,000, something they call “striking,” which suggests that the net benefits of portfolio reallocation have to be modest for the typical household, although it is possible that higher income households have more to gain.
The report states that a simple Excel exercise aimed at determining the required saving rates for individuals with different starting ages, ending ages and asset returns showed that the difference between earning a real return of 2% instead of 6% could be offset by working five years longer.
“This finding suggests a minor role for asset allocation in creating a secure retirement,” it says.
The second piece of analysis moved from hypothetical individuals to examining the effects of alternative strategies on actual households. The exercise consisted of estimating target and projected replacement rates for each household for ages 60 through 70. The metric of interest was the percent of households falling short. The baseline results showed that working longer substantially reduced that metric.
“Three other levers were evaluated against working longer: tapping home equity through a reverse mortgage, controlling spending, and investing 100% in ‘riskless equities.’ The results showed that, for the typical household, asset allocation was unimportant. The importance of asset allocation was somewhat greater for households in the top decile, but less than one would expect.”
The third exercise used something the authors refer to as “dynamic programming techniques” in order to calculate a risk-adjusted measure of the potential gain from portfolio rebalancing for both the typical household and the household in the top 10% of the financial wealth distribution. In all but one case, the dollar amount of the cost or benefit was equal to only a few additional months of work. In other words, asset allocation was not important, the authors concluded.
“Given the relative unimportance of asset allocations,” they wrote, “financial advisors will be of greater help to their clients if they focus on a broad array of tools–including working longer, controlling spending, and taking out a reverse mortgage.”