, Newburyport, MA


May 3, 2011

The age-allocation fallacy

There is a long-held adage that as we grow older the investments we depend on should grow more conservative.

Several factors should cause us to question that adage. First and foremost among the reasons to question this belief is that we are all living longer in retirement, that is, when we are older, and if we want our investments to last, being too conservative is risky.

Let's say you are 60 and you are healthy and about ready to retire. You expect to depend on your investments of $1.1 million for $5,000 a month, after taxes, adjusted annually for inflation. This withdrawal is sustainable for 40 years or more provided the investments are allocated 60 to 65 percent to stocks.

Healthy retirees, at least up until their mid-80s, need to manage their investments to a horizon of 20 to 30 years. So, even healthy 70-year-olds have a long-term horizon. To manage for the long term and to sustain reasonable withdrawals, there has to be healthy allocation to growth, even at the risk of greater volatility.

Another factor that calls the old adage into question is interest paid on bonds in the last three years is negligible, actually near zero. That means that a 70-year-old retiree with 70 percent in bonds would have experienced a significant and uncomfortable drop in interest income.

Furthermore, the adage assumes that stocks are high-risk investments that aging investors should steadily cut back on. Stocks are riskier and more volatile than bonds over most time periods, but as long as the time horizon is 15 years or more — the remaining life expectancy of the retiree — the risk in owning stocks seems overstated.

The adage of increasing bond exposure as a retiree ages is very conservative and risk-averse. Adhering to this adage may be appropriate for investors who have accumulated over $5 million. It may also be appropriate for those retirees who haven't saved enough and can't tolerate a moderately higher risk of loss associated with stocks.

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