Are you prepared to enter the danger zone? That's the time right around retirement when you have accumulated savings and are on the verge of drawing them down. A wrong move or a significant bear market at that point can have an outsized effect on your future financial life. The question is, what constitutes a wrong move? Many experts argue that those years are a time to pull in your horns and ratchet down the risk in your investments.
Prudential, which has actually trademarked the term
"retirement red zone," sees a variety of risks, in part from
people investing too aggressively to make up for lost time. Anthony Webb, a
senior research economist at the Center for Retirement Research at Boston
College, also believes it is wise to reduce equity exposure as retirement
nears. In addition, he said, young
people have plenty of low-risk assets in the form of the present value of their
future earnings, and relatively little to invest, so they can afford to take
more risk with the money they have. As people age, they tend to have less in
the way of future earnings and more in the way of savings, so ratcheting down
equity exposure to keep overall risk in check makes sense.
But a growing number of experts are arguing for a different
approach. Data from T. Rowe Price, for example, indicate that underexposure to
stocks past a certain point can actually hurt performance and send investors
into retirement with less money saved.
How much is too
little?
Investors tend to spend a lot of time on how much is too
much, they should also spend as much time thinking about how much is too little,
according to Jerome Clark, co-portfolio manager for T. Rowe Price's target date
funds. Clark and his colleagues compared a T. Rowe Price target date fund, with
its 55 percent stock allocation at age 65, to an index of other target date
funds, in which stocks account for 42.5 percent of assets for investors that
age. From 1965 to the end of 2014, the firm found that its fund would have
provided retirees with more money to draw down more than 99 percent of the
time.
That is particularly important now because people retiring
today may well live 30 years or more in retirement. A 65-year-old couple today
has a 19 percent chance that at least one of them will live to at least 95,
according to research by J.P.Morgan. In addition, with interest rates
currently so low, a significant exposure to fixed income carries its own risks.
A Prudential study of retirement savings found that an extended
period of low interest rates could increase the risk that a retiree would run
out of money from 21 percent to 54 percent.
So what's an investor to do with all this conflicting
advice?
One way to sift through the various recommendations is to
think carefully about your investment time horizon and your tolerance for risk.
If you expect to live in retirement for many years and you have a reasonable
appetite for risk, it may make sense to put retirement assets into a low-cost
annuity that guarantees some minimum income, and then consider how much of that
portfolio you want in stocks.
Prudential's Reddy argues that when investors in retirement
are out of the red zone and can protect themselves from the risk of too little
income by investing in an annuity, a 60 percent equity exposure within that annuity
structure is appropriate in retirement.
There is also another way to steer clear of the retirement
danger zone: Ease into your retirement. New T. Rowe Price research on
retirement saving and spending behaviors found that 22 percent of retirees who
retired with a rollover IRA or 401(k) were still working at least part time,
and 22 percent of the people in that group were working as much or more than
they were before.
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