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It’s a fact of life -- we’re living longer. But our money may not be keeping pace.
That’s why financial experts are questioning long-held assumptions about the best approach to investing as retirement nears. With life expectancies on the rise and fixed-income investments generating little in the way of actual income, many experts are starting to recommend that savers allocate less of their money to bonds and related assets than they used to think was optimal.
"You are likely going to need a higher level of equity exposure in retirement than previously has been used as a rule of thumb," said Katherine Roy, chief retirement strategist for JPMorgan's asset management unit.
The cost of living longer
Lengthening retirements are a key contributor to the shift in thinking by Roy and others. While there remains a troubling gap in life expectancies for minorities and whites, overall, American life expectancies have increased substantially, from 71.8 for men and 78.8 for women in 1990 to 76.2 for men and 81.0 for women as of 2010.
A woman age 65 in 2010 could expect to live 20.3 more years, up from 18.9 for a 65-year-old woman in 1990, according to the Centers for Disease Control. Remaining life expectancy for her male counterpart in 2010 was 17.7 years, compared to 15.1 years in 1990.
"You want to be planning for a retirement that could last 30 years or longer."
"You want to be planning for a retirement that could last 30 years or longer," said John Sweeney, executive vice president for retirement and investing strategies at Fidelity.
Hunting for yield
Interest rates are another challenge for soon-to-be retirees and those already out of the workforce. Ten years ago, it was possible to find a $100,000 CD that would yield 5 percent, generating $5,000 in income. But today, a six-month CD of that size would have a yield of less than 1 percent. Rates like that make it hard for people basing their portfolio around fixed-income assets to generate the income they need, unless they venture into riskier investments.
Prudential studied the effects of low-interest rates on income and found that for a hypothetical 65-year-old retiree with $300,000 who intends to withdraw $15,000 a year, the odds of running out of money increased from 21 percent to 54 percent when low interest rates were added to the financial model. (Tweet this)
"Finding a reasonable yield with a reasonable amount of risk has proven difficult in this interest rate environment," said Jeffrey Tomaneng, a financial advisor with Lincoln Investment Planning in Massachusetts. The portfolio managers he works with are starting to shift some of their clients' income allocation to "consider some alternative investments such as REITs, MLPs, commodities and hard assets," he said. (An MLP is a type of limited partnership that's publicly traded.)
Today's low inflation ought to be helping retirees contend with low-yielding investments, but JPMorgan's Roy said it is not that simple. Costs in some of the biggest expense categories for seniors are rising significantly faster than overall inflation, she said. For example, spending on health care for people in their 70s is six times what it is for consumers aged 25 to 44, and the firm calculates a 7 percent inflation rate in health care, she said. "Having a more diversified portfolio will help you keep pace with health-care costs."
Like JPMorgan, Fidelity has studied the changing retirement investment landscape, and as a result it has changed the asset allocation in its target date funds for people near retirement age. The Freedom 2015 fund had been invested 50 percent in equities, 40 percent in fixed income and 10 percent in short term instruments, but Fidelity in 2014 reduced the fixed income allocation to 34 percent and increased the equity portion to 56 percent.
The shift stemmed from three things, Sweeney said: Fidelity's capital markets forecast, Americans' increasing life expectancies, and investors' behavior after the financial crisis. Overall, he said, people stayed the course even when the market hit its lows, giving Fidelity confidence not only would equities generate the income and growth people sought, they would be comfortable with more equity exposure in a target date fund.
For its part, JPMorgan is seeing a shift in investing strategies among older people, Roy said, with a shift from roughly 30 percent equities to 40 percent and a concurrent decrease in fixed income exposure. And when she talks to financial advisors, "They are even thinking 40-60 for the post-retirement time frame may be too conservative."
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Creating a 'floor' portfolio
Certainly, stocks have had a remarkable run, and plenty of strategists worry that this is not the time to make a big move into stocks. Anand Rao, a partner at PwC, has worked with the Retirement Income Industry Association on a different approach to the whole retirement question. He believes it is important to develop an asset allocation built to meet different stages and conditions of life, and has been working to develop a concept called "building a floor." (PwC has a joint business relationship with the Retirement Income Industry Association.)
This approach to retirement investing calls for savers to allocate their money into a "floor" portfolio for non-discretionary needs like housing, a reserve portfolio for emergencies, a longevity portfolio for late in life, and an upside portfolio for everything else.
The reserve portfolio should be quite liquid, Rao said, and the floor portfolio should be in low-risk, income-generating assets such as Treasury bonds, annuities and the like. A longevity portfolio can build over time, and the upside portfolio can be invested for growth, with more allocated to equities.
Thinking through a plan like that would be challenging for many people on their own, but Rao said financial advisors can help. For investors without personal counselors, robo-advisors and their ilk could soon implement this kind of individualized approach, he said.
"With life expectancy increasing, you really can't afford to put the bulk of your discretionary money into just bonds or low-yielding vehicles," he said. In other words, if you go that route you may sleep a little easier at night now, but you may have even more worries to keep you up later.