Keep clients wary of retirement portfolio rules-of-thumb

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