Should You Reduce Risk Exposure As You Get Older?

By PAUL TAGHIBAGI | Special to the Palisadian-Post

If you move away from equities with age, are you making a mistake? For some time, financial professionals have encouraged investors to lessen their exposure to the stock market as they get older. After all, a 60-year-old has less time to recover from a market downturn than someone decades away from collecting Social Security checks.

Is that conventional thinking flawed? It might be. It isn’t simply a matter of looking at the future; you may also want to look at the past.

What’s the price of playing not to lose? It could be significant, at least in terms of opportunity cost.

Obviously, bonds, CDs and money market accounts will always hold some appeal as they tout protection of principal. Aside from that sense of safety, in spring 2016 the best rates on five-year CDs are barely exceeding 2 percent, a far cry from the 5-6 percent yields of previous decades.

While the Federal Reserve is now tightening monetary policy, interest rates are still near historic lows and will remain low for the near future. We have yet to see an inflation surge, even after years of easing by the Fed and other central banks.

Appetite for risk sent the Dow above 18,000 again in April. Yes, many investors moved money into cash earlier this year, but they may move it back soon if the major indices keep marching back toward their 2015 peaks.

Is the “glide path” strategy overrated? You may or may not have heard of this term; it refers to a gradual adjustment in asset allocation across an investor’s time horizon. With time, the asset allocation mix within the portfolio includes more fixed-income assets and fewer stocks, becoming more conservative. (This is the whole idea behind target date funds.)

Some question this approach. Research Affiliates CEO Rob Arnott looked at 140 years of bond and stock market returns and concluded that a glide path investing strategy pushes people out of equities too soon.

Arnott ran hundreds of model scenarios with mock portfolios, using three different asset allocation strategies and an initial investment of $1,000. One approach mimicked a target-date fund: an 80 percent/20 percent stock-to-bond glidepath to start, then a gradual decrease in the level of equity investment. Another portfolio had a constant 50 percent/50 percent allocation thanks to annual rebalancing. A third had an inverse glidepath: a 20 percent/80 percent stock-to-bond ratio to begin, evolving gradually to an 80 percent/20 percent stock-to-bond mix. Arnott found that across stock market history, the target-date fund approach finished last. The 50 percent/50 percent allocation approach beat it by 11 percent over 40 years, while the inverse glidepath approach outperformed it by 22 percent.

Retired investors should always maintain some exposure to stocks, as stocks have historically produced gains larger than those of other asset classes. The potential for higher returns also gives portfolios containing stocks the chance to beat inflation over time.

Ultimately, the individual’s financial situation and personal risk tolerance should dictate the amount of stocks in each portfolio.

Paul Taghibagi may be reached at (310) 712-2323 or pt@seia.com. http://seia.com/paul-taghibagi