Research released by the Putnam Institute today produced a conclusion that should shock the financial services industry, including the financial planning profession. The finding that the optimal equity allocation for retirees' portfolio is about 10% is so far out of line with conventional wisdom it left the study's author, Putnam Institute research director Van Harlow, quite surprised.
Depending on various factors, the optimal equity allocation could be as high as 25%, according to the research-still well below widely accepted thinking on retirement investing.
How did Putnam reach this radical conclusion? According to Harlow, the biggest risk retirees face is "sequence of return" risk, or retiring just as a nasty bear market begins.
Many academics and advisors consider longevity or inflation to be the biggest risk. But as folks who retired in 2000 or 2007 discovered, withdrawing money from a portfolio that has declined 25% to 45% in value can quickly place them in a hole they can't climb out of.
Once a retiree starts withdrawing money it "becomes path dependent," Harlow said today at a press conference. The day retirees stop earning money and living off their assets should be considered the so-called "terminal allocation," or the end of any roll-down. Putnam's research concluded it makes no sense to keep rolling down a retiree's equity exposure after this date.
As for longevity risk, Harlow found that if someone was certain to live to age 95, their equity allocation should be raised-all the way from 10% to 12%. This individual would be able to survive if she withdrew 3.9% of her assets.
One implication of Putnam's research is that most target-date funds are way too aggressive in their equity allocations. Today, target-date funds represent 12% of all defined contribution plan assets, but that figure is expected to rise to the 40% to 50% area over the next decade.
-Evan Simonoff