Every retiree’s biggest nightmare is running out of money after retirement.
A survey by the Allianz Center for the Future of Retirement revealed that approximately two-thirds (64%) of respondents said they were more worried about using up their savings than dying (1). But if you can not only reduce this risk, you can also Promote Could you save for retirement just by making small adjustments to how you allocate your money?
This is the basic argument of a 2013 study by financial experts Michael Kitces and Wade Pfau(2). Their analysis of historical market returns across different asset classes shows that an unconventional approach to asset allocation can have a significant impact on your chances of retirement success.
In fact, under ideal conditions, you might even be 500% wealthier than someone who takes a traditional approach to allocating their retirement portfolio. Here’s a closer look at the math.
Most retirees and financial planners use a simple rule of thumb (the Rule of 100) to structure their portfolio allocation in retirement(3). You simply subtract your age from 100 to determine your bond allocation, and put the remainder into stocks.
So, if you are 60 years old, 60% of your portfolio will be invested in safe bonds and the remaining 40% in stocks. As you get older, you’ll move more of your money into bonds.
The theory underlying this traditional approach is that your appetite for risk will diminish later in life. For example, if you are in your 80s, you don’t have enough time to experience and recover from a sharp decline in the stock market. Gradually increasing your bond allocation as you age can reduce this risk and volatility.
However, according to Kitces, this approach increases sequence risk, which is the risk that retirees experience large stock declines early in retirement (4). If a 60-year-old retires with 40% of her assets invested in stocks and experiences a bear market early in retirement, her savings may be permanently reduced in the long run.
That’s why Kitces and Pfau proposed an unconventional approach to contrarian portfolio allocation. They suggest retirees should keep more of their assets in safe bonds for the first five to seven years, rather than the simple 100 rule. This means retirees are less affected by the stock market downturn and have more time for the power of compound interest to work in their favor.
