Financial advisors tend to focus on financial assets during retirement planning, with particular emphasis on how those assets are allocated. However, a recent paper from the Center for Retirement Research at Boston College suggests that other levers may be more important for most households.
According to the paper, entitled How Important is Asset Allocation to Financial Security in Retirement?: “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. In contrast, they are often silent on the benefits of other options, such as delaying retirement, controlling spending or taking out a reverse mortgage.”
However, says lead researcher Alicia Munnell, even for clients with more substantial assets, these non-financial levers may be as powerful as asset allocation in attaining retirement security.
Because the typical savings of households approaching retirement is less than US$100,000, this focus on asset allocation is probably misplaced, the paper maintains, particularly given the risks that investing in stocks entails.
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 2% instead of 6% 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 a few more years.
It’s a simple equation, according to the paper: a later retirement age means that your clients have increased earnings, more time to save and fewer years in which they have to support themselves on their accumulated retirement assets, included indexed government benefits.
Another part of the study consisted of estimating target and projected income replacement rates for each household for ages 60 through 70, with particular emphasis on the percentage of households falling short.
Here, the asset-allocation decision was simply to allow each household to invest all of its assets in equities, earning a 6.5% 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 100% of assets in riskless equities, 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 report 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 vs those in the top 10% of financial wealth distribution.
In all but one case, the dollar amount of the cost or benefit 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 additional returns to improve their retirement income significantly.
Hopefully, your clients are not among them.
Regardless, according to the study’s conclusions, you will be of greater help to your clients if you suggest they focus on a broader array of tools, including working longer, controlling expenses and carefully tapping home equity.
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