About to retire? Check your stock exposure—quickly

We ran a simulation showing how various portfolio allocations performed for someone who had retired in 2000—and it was revealing.

  • By John Coumarianos,
  • The Wall Street Journal
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There are a lot of people thinking of retiring now because the bull market has boosted their 401(k)s.

But they may need to re-evaluate their allocations. And quickly.

Over the past decade, the S&P 500 (.SPX) has returned more than 13% on an annualized basis. And studies show that this is exactly when a lot of people choose to retire—the height of a bull market, when their portfolio is plump.

But those same studies show that people who retire at bull-market peaks have a higher chance of running out of money. That is because they wrongly assume big returns will continue to pile up—and then they lose a big chunk of cash when bear markets arrive.

So, investors about to retire may want to re-evaluate how their money is allocated. To assist in that effort, we ran a simulation showing how various portfolio allocations performed for someone who had retired in 2000, the beginning of a bear market, followed by another later in the decade.

We cherry-picked a retirement date with bad years at the beginning of the period, to counter the tendency for investors to focus on recent bull-market returns. For withdrawals, we applied one version of the “4% rule” that advisers often use, assuming retirees take out 4% of their account the first year, and then increase the dollar value of the initial amount by 3% in each subsequent year to account for inflation. Our simulation didn’t account for taxes, however.

Don’t scoff at bonds

First, let’s look at how a pure stock scenario played out.

We had our theoretical investor retire in 2000 with $500,000 fully invested in the S&P 500. Using the 4% rule, that nest egg eroded to less than $200,000 at the end of 2018.

Why? Although the S&P 500 produced a 4.86% annualized return over the 18 years of our study—and, of course, 13% returns from 2009 through 2018—it experienced two declines of roughly 50% (2000-02 and 2008-early 2009) within the first decade. Bad early years in a withdrawal phase can crush a portfolio; the double whammy of withdrawals and losses means there isn’t enough money or time left for a roaring market later on to restore a portfolio to its original balance later.

But increasing bond exposure, represented by the Bloomberg Barclays U.S. Aggregate index, helped the portfolio to hold up.

A $500,000 investment in a balanced allocation (60% stocks, 40% bonds) would have been worth around $424,000 in 2018 using the 4% withdrawal rule. And a conservative portfolio (30% stocks/70% bonds) would have had around $508,000 at the end of 2018.

That is mainly because bond-heavy portfolios protected against big losses in the early years. Bonds’ annualized returns for the whole period of the study were on par with those of stocks—4.84% for bonds vs. 4.86% for stocks—but bond returns held steady in the market downturns. In 2000-02, bonds gained a cumulative 33.5%, and they returned 5.2% in 2008-09.

Stick to 60% or less stock exposure

All of this means investors on the verge of retirement should contemplate having no more than 60% stock exposure and might prefer less. And that is what we found when we examined the funds in Morningstar’s Target Date 2020 fund category. No fund had more than 63% stock exposure, and the average stock exposure for funds in the category was 43%. Beyond stocks and bonds, the average fund’s cash position was nearly 14%.

Among the largest funds, only T. Rowe Price Retirement 2020 (TRRBX) exceeds 55% stock exposure. The two largest funds in the category, Vanguard Target Retirement 2020 fund (VTWNX) and Fidelity Freedom 2020 fund (FFFDX), clock in with 51% of their portfolios in stocks. American Funds 2020 Target Date Retirement (RECTX) and TIAA-CREF Lifecycle 2020 fund (TCLTX) have less than 50% stock exposure, while JPMorgan SmartRetirement 2020 (JTTIX) has less than 40% stock exposure.

If 2020 brings another market cycle like the one that started in 2000, these funds should allow investors in retirement to take a modicum of income without elevated stock exposure destroying account balances. All of that is provided that investors can hold the allocation through thick and thin.

Whether or not investors use these funds, they should think about their current allocations or consult their financial adviser. The question they need to ask is: If they are going the traditional route, and consuming 3% to 4% of their saved assets every year, do they really want to bet that the bull market will continue?

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