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Retirement Glide Path: Is Comfort Key?

Christine Benz
David Blanchett

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Some of the most important recent research in the realm of retirement planning has been in the area of asset allocations during retirement. Joining me to discuss his research in this area is David Blanchett--he is head of retirement research for Morningstar Investment Management.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: David, let's start with the standard in-retirement glide path that calls for ever-declining stakes in stocks as the years go by. Let's talk about the fundamental thesis behind doing that.

Blanchett: So, the glide path is how the allocation to stocks changes over time. And I think most people, when they think about glide path, they think about accumulation--things like a target-date fund, where if you are, say, age 25, you are in mostly stocks, and as you approach retirement, it becomes more conservative.

There has been an ongoing question about how do you allocate in a portfolio during retirement. Should the portfolio become more aggressive or more conservative? The consensus has really been that it should be more conservative as you age; a great heuristic is 100 minus your age. That's your target equity allocation. So, if you are 65 years old, 100 minus 65 is 35% in stocks.

Recently, though, we've seen some discussion about [whether that equity allocation should be] increasing or decreasing, and I think that basic economic theory would suggest that people should allocate their portfolio like a completion portfolio. How risky are your other assets? When you're younger, you have a lot of human capital. Human capital is very bondlike, and so that gives credence to the idea of having a more conservative glide path in accumulation. There is obviously a bigger debate, though, about retirement.

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Benz: You alluded to the fact that there has been some recent research; Michael Kitces and Wade Pfau took a look at whether retirees ought to start out with fairly light equity weightings and then ramp them up over time. Let's discuss the fundamental underpinning [of that]--what they were trying to get at by having retirees come into retirement with a pretty light equity stake.

Blanchett: So, when you first retire, you are subject to what's called sequence risk, which is where the initial returns are very impactful on the results of your eventual retirement and your success. One school of thought is that you want to be conservative early to minimize the impact of sequence risk. Another school of thought would be that you need to actually do well early in retirement, especially today, given the fact that returns are so low. Given those two competing thoughts, how do you create the right allocation to last for 30-plus years of retirement?

Benz: One follow-up question to this idea of sequencing risk. If retirees have appropriately asset-allocated portfolios--so if they have enough cash and enough bonds to get them through a catastrophic equity-market return in their early retirement years--shouldn't that help obviate concerns over sequencing risk?

Blanchett: It does, and so that's kind of the idea of a bucket strategy--

Benz: Exactly.

Blanchett: --where you are allocating certain parts of your portfolio to different years of retirement, and I think that that's definitely the case. But in reality, if you do have that cash and that fixed bucket, and if the markets were to go down and you spend all that cash and bonds, you may only have equities left. And so [my thoughts on the bucket approach are] that it's an excellent behavioral way to view portfolios, but in reality, you can cut up any portfolio into as many buckets as you'd like to.

Benz: Let's talk about your most recent research on the topic--some of the variables that you looked at to help determine what the best glide path is. What did you do in your most recent work?

Blanchett: So, today, retirees are really in a difficult place. Right now, we're at a very unique time in history versus the last, say, 130 years of the U.S. stock market and bond market. Yields are very low. The bond yield on the 10-year Treasury is about 2%-ish, and the market valuation based upon the Shiller P/E is very high. So, the expectations today for both bond returns and stock returns are very low. And if you combine these two variables together, it does suggest that maybe a decreasing glide path that becomes more conservative in retirement is better than a rising glide path; but in the grand scheme of things, the differences aren't that great--whether you have kind of a constant, static allocation or an increasing or decreasing glide path.

Benz: So, it sounds like my own comfort level with this setup is an essential ingredient here?

Blanchett: It really is. And one thing that my model totally excludes is your preference for risk. These are all models built upon what best helps you accomplish the goal. But how do you feel about risk in retirement? If you are like most people, then as you age, you want to be more conservative in your portfolio; and I think that further gives credit to the idea that you should be more conservative as you age in retirement.

Benz: How about the keep-it-simple approach, where rather than adopting any sort of glide path that's going up or down, maybe I just go 60% equity and 40% bond or 50-50, and then just rebalance back to that target?

Blanchett: That's, I think, an excellent strategy. And actually, Michael and Wade note the same thing--that it's really hard to beat a good balanced portfolio.

Benz: David, thank you so much for being here. This is such an important area. I know it's top of mind for a lot of retirees.

Blanchett: Thanks for having me.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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