New strategy for equity investing during retirement ignites debate

Michael Kitces

A new paper that suggests rising equity exposure in retirement may in fact lead to better outcomes has set the web abuzz.

Financial planning literati Wade D. Pfau, professor of retirement income at The American College, and Michael Kitces, partner and director of research at Pinnacle Advisory Group, released a paper earlier this fall entitled “Reducing Retirement Risk with a Rising Equity Glidepath.”

The paper turns conventional retirement income strategy on its head. Mr. Kitces and Mr. Pfau observe that a U-shaped glide path in retirement — one in which equities are at their lowest allocation in the retirement transition and then rise afterward — is preferable to the standard downward slope of equity allocation as a client ages.

“Just as equity exposure can be more beneficial for those who are very young, so too can greater equity exposure in the later years of retirement actually help,” Mr. Kitces and Mr. Pfau wrote. “Especially in those scenarios where returns in the early retirement years are poor and favorable returns — with a healthy amount of equity exposure — are crucial to allow the portfolio to last.”

Those first 15 years of retirement are crucial: A strong market early in the client's retirement will put the investor far ahead of his or her goal, enough to buffer the effects of a bear market later in retirement, according to the paper. Meanwhile, if returns are poor in the first 15 years, the portfolio will need strong returns in the second half of retirement to ensure it lasts.

The paper aims for a starting point in retirement of about 20% to 40% in equity allocation, with a gradual increase of 1% per year to a maximum 60% to 80% allocation to stocks by the end.

The concept is generating plenty of discussion. “Sure. Why not. Let's allocate 90-year-old grandma to 90% stocks,” tweeted Moshe A. Milevsky, professor at the Schulich School of Business at York University in Toronto.

Sure. Why not. Lets allocate 90 year-old grandma to 90% stocks. http://t.co/dcC0JhZwpH

— Moshe A. Milevsky (@RetirementQuant) November 26, 2013

John Rekenthaler, vice president of research at Morningstar Inc., posted a rebuttal to the paper on Wednesday, asserting that at a starting point of 30% equities at retirement (culminating at 60%) with a 4% withdrawal rate, the “rising equities” path leads to only slightly better outcomes than taking a fixed glide path of 45% stocks and 55% bonds.

Mr. Rekenthaler argues that with a 25% average weighting in stocks in retirement, in which the rising glide path begins at 10% in stocks and ends at 40%, would not fare as well as a traditional glide path that starts at 40% in stocks at retirement and declines t! o 10%.

The article elicited a volley of tweets from Mr. Kitces and some lengthy comments on the page with the Morningstar article. “His 'proof' that the strategy doesn't work is in scenarios that have 50/50 chance of catastrophe anyway,” Mr. Kitces tweeted.

@jerrykerns His 'proof' the strategy doesn't work is in scenarios that have 50/50 chance of catastrophe anyway. @WadePfau

— MichaelKitces (@MichaelKitces) December 4, 2013

Mr. Rekenthaler shot back that a “25% equity position, like it or not, is the current status of many/most retiree stakes.”

He wrote” “I thought it was worth a look to see how the thesis played out at the asset mix that many people have.”

And also SWR research says 50-75% stocks throughout retirement, so we are more conservative; not Dow 36,000 @jerrykerns @MichaelKitces

— Wade Pfau (@WadePfau) December 5, 2013

Mr. Kitces noted that he hasn't heard much yet from the financial planning community on his findings. "A lot of people are stunned and trying to take it in," he said. "It's a very new discussion." The final version of the paper will be released in the January issue of the Journal of Financial Planning.

Either way, expect the contretemps to continue: Mr. Rekenthaler says he will post a follow-up to his critique of the paper today.

RT @jerrykerns: In comments section, @MichaelKitces responds to Rekenthaler's critique. http://t.co/j2VT2cEq1S

— MichaelKitces (@MichaelKitces) December 4, 2013