KellyGreene

Experts are starting to rethink how much stock people should hold in retirement.

In general, the new thinking goes, people should be more heavily invested in equities than is suggested by some traditional rules of thumb, such as subtracting one’s age from 100 to determine a portfolio’s stock allocation. One new, and controversial, theory even goes so far as to suggest that stock exposure should increase the further one moves into retirement.

What hangs in the balance: whether 78 million baby boomers can generate sizable enough returns, without taking on too much risk, to create income streams that last as long as they do.

Here are three different approaches financial experts are pushing, all of which conclude that people should be investing more heavily in stocks — even after they’ve collected the gold watch:

First reduce, then increase equity allocation over time

One of the biggest risks in using investments to fund retirement is what’s called “sequence of returns” risk. If you retire and your investments take a big hit during the first few years you’re making withdrawals, the money will run out years earlier than if you have decent returns earlier and suffer through a market downturn later.

To combat the problem, two researchers recently crunched the numbers and concluded that, in many cases, investors should dial back their stockholdings to between 20% and 50% at the start of retirement and then ramp them back up by one percentage point a year to between 40% and 80% throughout retirement. For example, a portfolio that starts at 30% in stocks and finishes at 60% performs better on average than one that starts and finishes with 60% stocks.

“You want to have the lowest stock allocation when your portfolio is largest, and that’s going to be right before and after retirement. That’s when you’re most vulnerable to losing wealth.” Wade Pfau

“You want to have the lowest stock allocation when your portfolio is largest, and that’s going to be right before and after retirement,” said Wade Pfau, a retirement-income professor at American College in Bryn Mawr, Pa. who did the research with Michael Kitces, research director of Pinnacle Advisory Group in Columbia, Md. “That’s when you’re most vulnerable to losing wealth. Once you transition into retirement, you no longer have as much ability to change your plans and make it back up.”

The researchers describe their asset-allocation recommendation as a “U-shaped glide path,” where stocks start as a large share of the portfolio, decline, and then are increased over time. Ideally, the researchers say, they would like to see their recommendation incorporated into the asset allocations used by target-date funds, which base their allocations on retirement dates and ages in an attempt to allow investors to put their investment goals on autopilot, Pfau said.

So far, though, target-date funds, at best, keep a fixed portion of assets in stocks through the retirement years, and most have a declining share in equities. “They’re exposing you to potentially worse outcomes by having a declining glide path in retirement,” Pfau warned.

Says Kitces: “If I say, ‘You’re going to invest more in equities later in retirement,’ everyone freaks out.” But he and Pfau say retirees’ actual behavior in the past, when more people relied on traditional pensions, matches up to their findings.

People funding their fixed costs with a combination of a pension and Social Security or other annuity payments sometimes invested much of the rest of their assets in stocks, Pfau said. So, as they aged and the remaining value of those fixed-income sources effectively declined, they essentially had more of their investments in stocks.

Divide assets into five buckets that can last 30 years

For years, many financial planners advised investors at retirement to weight their portfolios heavily to bonds. Some now argue that the main underlying assumptions behind that recommendation no longer apply.

For one thing, “we’re ending a 30-year bull market in bonds,” said Lisa Shalett, head of investment and portfolio solutions for Morgan Stanley Wealth Management. For another, the investment horizon for most retirees has lengthened to 30 years from 10, along with the general rise in longevity for the U.S. population. And lastly, the shift from pension plans to 401(k) retirement plans has more retirees depending on investment gains for income.