Market Mini: Rule of 100 … NOT! Reduce Retirement Risk with More Stocks

Posted By on Jan 10, 2014|0 comments


It is a common belief that retirees should have fewer stocks as they progress through retirement and grow older. This belief, commonly called the “Rule of 100” suggests people take  the number 100 and subtract their age in order to understand the amount of stocks they should have.  Additionally, most target date funds are based on the assumption that as we near a retirement date, we should have less invested in stocks.

However, recent research by Michael E. Kitces and Wade D. Pfau suggests this to be all wrong. Their research, titled Reducing Retirement Risk with a Rising Equity Glide Path, indicates that having more stock exposure reduces the risk of running out of money for individuals. More specifically, they found that having more money in stocks reduces both the probability and magnitude of failure for client portfolios.

The study begins with a review of past research that suggests different asset allocation glide path strategies can impact the amount of wealth accumulated at the targeted retirement date.

The basic idea around the study involves starting stock exposure between 20% and 40% and over time increasing the exposure to somewhere between 60% and 80%. Kitces and Pfau found that this approach performed better at sustaining retirement income and reducing shortfalls when the market declines.

The main reason that increasing stocks is favorable is that in a situation where retirees experience a decline in stock prices (e.g., during 1929 or the late 1960s), rising stock exposure allows the individual to gradually gain exposure into stocks, rather than having greater exposure that falls dramatically. As a result, exposure increases as stock prices improve and an individual can regain and surpass previous values.

Kitces and Pfau indicate the risk to this strategy is the following:

“Notably, the clear caveat and concern of this approach is that it may also create concerns for seniors in their later years, who may not be comfortable from a risk tolerance perspective handling the greater equity exposures implied by this approach (even if the results would technically be optimal from the mathematical and markets perspective).”

The implication for financial advisors is that traditional approaches such as the rule of 100 or target date funds are simply inferior methods.

I feel that the Kitces and Pfau are absolutely correct in their belief that an extension of this research should be to “incorporate measures of valuation more directly.”

When research is able to turn common beliefs upside down, I find that this creates the greatest impact. Kitces and Pfau have done this here and have extended an approach for financial planners to incorporate with their clients.

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