Benz: You have done some research. You co-authored a paper with professor Wade Pfau where you looked at what equity allocations should look like in retirement. And your research came up with a somewhat counterintuitive finding, where you actually suggested that equities should trend up as someone goes further in retirement. Let's talk about your general findings and why you think that this is maybe something that retirees should look at?
Kitces: Certainly the reactions to some of the
research that we've done have been interesting at the suggestion that
maybe equities should actually glide upward and you would get a little
bit more aggressive through retirement.
We see a natural retiree bias toward that anyways. We don't really
want to own any more equities than we have to. [They can be] a little
volatile and a little scary. And we've had this kind of rule of thumb
for a very long time of "Own your age in bonds, or 100 minus your age in
stocks," all of which gets you to the same point. As you're getting
older your equity exposure declines and that was a way to own fewer
equities through retirement.
The problem is that particular approach where you decrease them over
time, psychologically I think there is some comfort to it. Unfortunately
from the research, it just doesn't work very well. [Financial expert]
Bill Bengen did some work on this back in the late 1990s after he had
done his initial safe withdrawal-rate research and found that decreasing
equity exposure through your retirement hurts; you got lower income and
withdrawal rates. Not a huge difference if you only did a little bit of
trimming, but you got lower outcomes.
David Blanchett, Morningstar's head of retirement research, did a
wonderful study on this six or seven years ago where he tested something
like 43 different versions of decreasing equities--so you decrease by
little a year or a lot every year, or a little bit and then more, or
more and then a little bit--all the different ways that we could glide
that equity exposure down. And basically what he found was just sticking
with the same balanced portfolio and rebalancing to it worked better
than all of these decreasing-equity-exposure approaches.
What Wade and I did was really just kind of take it one step further
and ask, "If starting [with higher equity allocations] and coming down
doesn't work very well and starting [at one level of allocation] and
sticking [with that same level of allocation over time] goes better,
what would happen if we started lower and glide it back up to where we
were going to be in the first place?" So we'll own less in equities
early on and will maybe end out with a portfolio that we would have held
throughout anyways. So, if I were going to be 60%-40% in retirement,
we're never going to go higher than 60%, but rather than being 60%
equities every year, what if we went down to 30% in equities and then
started gliding back up toward that original 60% target. And what we
found was it actually works.
One of the key things to note about that coming right out of the gate,
though, is equities would be gliding upward through retirement, starting
from a much more conservative point. While a lot of the discussions
around this have been framed as "How aggressive is it to be adding
equities for people through retirement?"--what we were actually finding
is that this is a strategy to give you lower equities in retirement,
lower average equity exposure overall, just doing it in a manner that
works a little bit better.