Reducing Retirement Risk with a Rising Equity Glide-Path
Wade D. Pfau
The American College
Michael E. Kitces
The Kitces Report & Nerd's Eye View; Pinnacle Advisory Group
September 12, 2013
This study explores the issue of what is an appropriate default equity glide-path for client portfolios during the retirement phase of the life cycle. We find, surprisingly, that rising equity glide-paths in retirement – where the portfolio starts out conservative and becomes more aggressive through the retirement time horizon – have the potential to actually reduce both the probability of failure and the magnitude of failure for client portfolios. This result may appear counter-intuitive from the traditional perspective, which is that equity exposure should decrease throughout retirement as the retiree’s time horizon (and life expectancy) shrinks and mortality looms. Yet the conclusion is actually entirely logical when viewed from the perspective of what scenarios cause a client’s retirement to “fail” in the first place. In scenarios that threaten retirement sustainability – e.g., an extended period of poor returns in the first half of retirement – a declining equity exposure over time will lead the retiree to have the least in stocks if/when the good returns finally show up in the second half of retirement (assuming the entire retirement period does not experience continuing poor returns). With a rising equity glide-path, the retiree is less exposed to losses when most vulnerable in early retirement and the equity exposure is greater by the time subsequent good returns finally show up. In turn, this helps to sustain greater retirement income over the entire time period. Conversely, using a rising equity glide-path in scenarios where equity returns are good early on, the retiree is so far ahead that their subsequent asset allocation choices do not impact the chances to achieve the original retirement goal.
Number of Pages in PDF File: 19
Keywords: retirement planning, investing, asset allocation, glide-path
JEL Classification: D1, G2working papers series
Date posted: September 13, 2013
© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo8 in 0.312 seconds