Many financial advisors counsel their elderly clients to take a conservative approach in investing their retirement portfolios. This may not be the best advice if the assets are going to have to last 30 or 40 years, according to an article in the December 2001 issue of the Journal of Financial Planning ( 'Making Retirement Income Last a Lifetime,' by John Ameriks, Robert Veres and Mark J. Warshawsky.)
In the article, the authors look at how much retirees should withdraw each year from their retirement portfolios and the investment strategy that will make assets last as long as possible. In a world where 60-year-olds living to 100 is an increasingly common scenario, a 20- or 30-year time horizon may not be long enough, they point out.
Looking at the historical record from 1946 to 1999, the authors conclude that investing retirement savings conservatively (20 percent stocks, 50 percent bonds, 30 percent cash) offered only limited protection against loss and greatly restricted the gains that were possible from the stock market upsurge. But since it is doubtful that this historical record will be replicated in the future, the authors performed what is called a 'Monte Carlo analysis' of 10,000 hypothetical asset return histories. In effect, they took economic data for each month over the past 34 years and shuffled the resulting 'cards' 10,000 times, creating 10,000 different economic scenarios.
Looking at the results, they found that if each year an investor withdrew 4.5 percent of the assets from an aggressively invested portfolio (85 percent stocks/15 percent bonds), the portfolio would still be there after 30 years about 92 percent of the time. Over 40 years, the portfolio was still in existence nearly 88 percent of the time. Surprisingly, the chances that the portfolio would dry up after 30 years were far greater with the conservative approach: the possibility of portfolio extinction before 30 years was more than 67 percent. Over shorter retirement periods like 20 years, the conservative portfolio was somewhat more reliable than an aggressive approach. In addition, the authors point out that the more stock-heavy portfolios come with a much more disastrous, although relatively rare, downside.
To download the article in PDF (Adobe Acrobat) format, click here.
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