Just how important is asset mix in retirement?
Financial advisors tend to focus on clients’ assets during retirement planning, with particular emphasis on how those savings are allocated.
It’s a pretty standard conversation: When do you see yourself retiring? How much do you have in your RRSP or TFSA? What's your current mix of stocks, bonds, and cash?
It’s important stuff. After all, the older you get, the more conservative your portfolio should probably be.
What really matters, of course, are your personal financial circumstances – specifically, the length of time you plan to keep this money invested, and perhaps more important, how much risk you're comfortable shouldering over time.
Which means that levers other than asset mix may be crucial for many households, according to a recent study from the Center for Retirement Research at Boston College,
“Financial planning tools frequently highlight the asset-allocation decision, suggesting that individuals have a lot to gain by adopting a more optimal allocation of stocks and bonds,” says Center director Alicia Munnell.
“In contrast, they’re often silent on the benefits of other options, such as delaying retirement, controlling spending or taking out a reverse mortgage.”
However, she maintains, even for those with fairly substantial assets, these non-financial levers may be as powerful as asset allocation in attaining retirement security.
According to her research, the typical savings of households approaching retirement is less than $100,000, excluding home equity. If that’s true then even perfect investing is unlikely to have a significant effect on their well-being in retirement.
After determining the required saving rates for individuals with different starting and ending ages, as well as accounting for varying returns, the study points out that the difference between earning a real return of two per cent instead of six per cent could be offset by merely working five years longer.
And the more progress people have made in their careers, the greater the impact of working those extra years. The biggest financial boost comes from having to support fewer years as a retiree.
It's a simple equation: a later retirement age means increased earnings, more time to save and fewer years in which you have to support yourself on your accumulated retirement assets.
It will also boost the amount of money you’ll eventually earn from indexed government benefits.
Another part of the study consisted of estimating target and projected income replacement rates for those retiring at ages 60 through 70, with particular emphasis on the percentage of those likely to come up short of reasonable spending goals.
Here, the asset-allocation decision was simply to allow each household to invest all of its assets in stocks, earning a ‘wouldn’t-that-be-nice’ 6.5 per cent real return and facing no costs associated with the increased risk.
This fictional investment effectively gave asset mix a head start in the race to see which pre-retirement strategy was most effective, the idea being that if asset allocation didn't dominate the other levers in this instance, it never would.
Again, after considering tapping home equity through a reverse mortgage, controlling spending and even investing every cent of your money in ‘riskless’ stocks, working longer still proved to be the most effective strategy for the population as a whole.
Asset allocation was somewhat more important for more affluent households, the study notes, "but less than one would expect."
Really though, that's the case for most of these variables. The relative impact of a reverse mortgage is smaller for wealthier households, for instance, because their home probably represents a smaller percentage of their total wealth.
The final segment of the study calculated risk-adjusted measures of the potential gains from portfolio rebalancing for households with modest savings versus those with much greater wealth.
In all but one case, the increase in dollars was equal to only a few additional months of work before retiring. Again, the study concluded, asset allocation was simply not all that important.
Of course, the main reason asset mix doesn't do the job is that too few households have a large enough portfolio for any additional returns to improve their retirement situation significantly.
Hopefully, you’re not among them.
It’s not that asset allocation isn’t important, because it is. But, rather than spend all your time worrying about it, maybe you should focus on actions that make it easier to work longer, like education, on-the-job training, networking and maintaining your health, Munnell says.
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