Close Close

Portfolio > Portfolio Construction

Keep clients wary of retirement portfolio rules-of-thumb

Your article was successfully shared with the contacts you provided.

The television was on in the background recently and the report caught my attention. The personal finance reporter/pundit was confidently informing viewers that they should set their portfolio allocation according to the “100 minus your age in equities” formula. In other words, a 50-year-old would have 50 percent of his or her portfolio in stocks; a 60-year-old would have 40 percent, and so on. Sometimes the rule is expressed as “hold your age in bonds,” but the result is the same: investors should move to fixed income as they age.

The reporter’s pronouncement and elaboration on the rule’s utility for retired investors surprised me because I hadn’t encountered it among financial advisors in years. The rule does have some value—it can be a useful starting point for a discussion with clients, particularly those who are violating the rule in some extreme manner. But the automatic application of a simple financial axiom is risky for the retired client’s financial well-being, unless that client meets the assumed criteria.

Too broad to be useful

The 100-minus-your-age rule overlooks multiple factors. From a broad allocation perspective, recent research that Wade Pfau and Michael Kitces published in the January 2014 Journal of Financial Planning indicates that increasing instead of decreasinga retiree’s equity allocation over time can be beneficial. From the executive summary of their article: “Overall, the results show that rising equity glide paths from conservative starting points can achieve superior results, even with lower average lifetime equity exposure. For instance, a portfolio that starts at 30 percent in equities and finishes at 60 percent performs better than a portfolio that starts and finishes at 60 percent equities. A steady or rising glide path provides superior results compared to starting at 60 percent equities and declining to 30 percent over time.”

The rule also assumes universal levels of risk capacity and risk tolerance among retirees. Advisors know from experience that those two measures can vary greatly, even among retirees with similar financial circumstances. “Many people have differences from one situation to the other so that’s where we really back away from most rules-of-thumb,” says Kevin Meehan with the Wealth Enhancement Group in Chicago, Illinois. “Somebody might have a different Social Security strategy. Somebody might have a pension. Somebody might have a desire to leave money to heirs. Someone else might not care if they leave money for anyone else. Somebody might receive an inheritance later on. Somebody will never receive an inheritance.”

Too narrow in focus

Another problem is that the rule assumes just two investment asset classes: equities and fixed income. That constraint applied historically to many investors but the emergence of liquid alternative mutual funds and exchange-traded products (ETPs) is increasing investors’ diversification options.

Admittedly, some advisors and investors reject alternatives out-of-hand as being too expensive or volatile for retirees’ portfolios. That reaction might be based on two misconceptions. One is that all alternative strategies aim for high returns and consequently involve high volatility. That’s true for some strategies, but others aim to provide more modest, non-correlated, lower volatility returns. In baseball parlance, they’re going for singles and doubles, not home runs, and they have the potential to increase portfolio diversification. These results aren’t guaranteed, of course, but it’s useful to avoid dismissing the strategies by lumping them together.

It’s also helpful to distinguish between strategies (long/short, market neutral, relative value, etc.) and the investment vehicles used to access those strategies. Investors often equate alternatives with hedge funds and private partnerships and the fees associated with those illiquid and opaque structures. Mutual funds and ETPs’ fees and portfolios are more transparent, allowing investors to determine if a particular vehicle is reasonably priced and suitable for the investor’s goals.

Be prepared

Meehan reports that he encounters client queries on the popular rules-of-them frequently. Sticking with a financial planning approach that understands the clients’ total circumstances can help them avoid getting distracted, he says. “Be careful before you buy into rule of thumbs,” he advises clients. “Instead, really look at the unique issues to your circumstance related to your priorities, your resources and future changes that you can project and then build it off that and review it consistently.”


© 2023 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.