(September 18, 2013) — Retirees should increase their equity allocations through the retirement time horizon to maximize their retirement income and reduce risk, according to research.
The study, “Reducing Retirement Risk with a Rising Equity Glidepath,” written by Wade Pfau from the American College and Michael Kitces of the Pinnacle Advisory Group, analyzed the sustainability of constant inflation-adjusted spending strategies from a portfolio of assets.
Their findings evaluated various withdrawal rates and outcome measures of failure rate, magnitude of failure, upside potential of the strategy, and the maximum sustainable withdrawal rate supported at the 10th percentile of outcomes. The results revealed that equity exposure in the later years of retirement is beneficial.
In fact, portfolios that began with 20% to 40% in equities and increased to 60% to 80% in equities were found to be optimal. This strategy would reduce equity exposure during the years with the biggest portfolio size.
The study found rising equity glide paths perform better than static asset allocations or declining equity glide paths.
This “Heads you win, tails you don’t lose,” outcome will be successful in sustaining retirement income under two varying scenarios.
If the equity returns are poor in the beginning of the retirement, Pfau and Kitces’ theory contended that increasing equity allocations would maximize exposure in time for the good returns. If the equity returns are strong in the early years, the retiree can rest easy since they would cushion a later bear market.
The authors also argued for the strategy in circumstances where equity risk premium is low. The optimal portfolio would utilize fewer stocks than in typical markets, but still maintain the rise throughout the retirement period.
The researchers’ results were consistent with shorter and longer time horizons: increasing equity exposures through retirement minimized the risk of failure.
The full paper can be found here.
Related content: Testing the Target-Date Theory, Beware of the End of the Glide Path