Discontent with equity investing for retirement is metastasizing from Main Street to the ivory towers inhabited by serious financial minds. In the past year, a growing chorus of academics and other thought leaders have started questioning what once were bedrock assumptions about equity allocations for retirees.
It may be purely coincidental but the rising aversion to equities comes after a ten-year bear market that has witnessed two of the four 50%-plus corrections in the last century. But consequential thinkers like Barra founder Andrew Rudd and Bryce Harlow, who heads the Putnam Institute, are reaching very different conclusions from the widely accepted view among investment professionals that a 50% to 60% allocation to equities, or even higher, is sensible for most retirees.
Both Rudd and Harlow are serious thinkers with doctoral degrees from top-flight universities, the University of California at Berkeley and the University of Texas, respectively, and spent their careers straddling the worlds of real asset management and academia. As a result, they understand what's taking place on the frontlines of investment theory and what's working in the real world.
In the wake of two once-in-a-lifetime bear markets compressed into a single decade, one can certainly make the case that a reappraisal of conventional wisdom is in order. Last summer I interviewed Harlow, who said that when he began his research, he thought the traditional pension allocation of 60% equities and 40% fixed income that performs well under many scenarios would emerge as a near-optimal solution.
What Harlow discovered is what many folks who have retired in the last decade have learned the hard way. One of the greatest-and, until recently, least appreciated-risks for a retiree is the sequence-of-returns risk. People who retired in years like 1893, 1929, 1965, 2000 and 2007 with much of their net worth in equities probably wish they had stayed on the job.
Harlow told me that he assumed someone could enter retirement with a traditional 60%-40% portfolio and gradually "roll down" her equity exposure over time. That works as long as the person isn't slammed with a nasty bear market at the onset of retirement. But people are not pension funds or endowments and may not have the time horizons or risk tolerance levels those institutions do.
Harlow's conclusion that retirees should invest 5% to 25% of their assets in equities if they are concerned about outliving their assets pours a bucket of cold water on mainstream financial planning. Significantly, allocations in the 10% to 12% area are considered optimal. For his part, Rudd agrees that such weightings are appropriate for all but the affluent.
Why so conservative? Harlow explains that once a retiree starts drawing down assets, the glidepath becomes path dependent.
One might suspect that his statistical findings are heavily influenced by the dismal returns from equities over the last decade. Au contraire, he responds. Harlow says one derives nearly identical results whether one runs Monte Carlo simulations using 30-year returns or 80-year results.
Of course, the sequential risk argument can be flipped on its head. What if someone retired in 1919, or 1948 or 1982 and went to 12% equities?