Reducing Retirement Risk with a Rising Equity Glide-Path (Digest Summary)

The authors consider the merits of increasing the proportion of a retiree’s assets in equities over the course of his or her retirement, arguing that such an approach is more effective than the traditional approach for preserving an income stream and preventing a depletion of retirement assets.

The argument the authors present runs counter to the prevailing wisdom that individuals should position assets in a way that reduces risk and volatility (e.g., increase the allocation to bonds approaching and during retirement).

By increasing the proportion of retirement assets in equities, the retiree is less exposed to losses initially because a greater amount of his or her assets reside in fixed income and can satisfy the greater spending needs retirees often face as they enter retirement. Over time, as the equity portion of these assets eventually rises, the retiree is exposed to strong performance that increases account value and sustains income.

Arguably, a small number of sophisticated investors will be able to undertake dynamic asset allocation by matching assets and liabilities—that is, by paying close attention to the funded status of their retirement assets and risk tolerance. But most individuals rely on life-cycle or target-date funds. Some may have more complex spending goals for both the present and future, and such individuals need to determine an appropriate equity glide-path during retirement.

Financial advisers and planners could find the conclusions of this article to be relevant and applicable to their work with clients, as could portfolio managers of life-cycle or target-date funds with dynamic asset allocations.

Increasing the proportion of retirement assets in equity for the duration of an individual’s retirement is demonstrated by the authors to be a more effective way of maintaining and securing a robust asset base and income stream in retirement than the traditional approach. A rising allocation to equities helps to guard against depleting assets, given the growth potential of the asset class and the possibility of dollar-cost averaging into it when stock prices (and, by implication, the equity risk premium) are down so as to be better positioned for an eventual increase. A consideration for future research that the authors appear to omit is how their approach might reconcile with the fallacy of time diversification, particularly in the later years of a retiree’s life, when time horizons are shorter. Testing a wider range of glide-paths may partially address this issue.