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Is 100% Stocks OK for a Retirement Portfolio?

A reader writes in, asking:

“Both my wife and I expect to retire within 5-10 years. We’ve never owned any bonds. Our portfolio has been all stocks right from the start: first investing in specific stocks, then mutual funds, and most recently a portfolio of index funds. I’ve read over and over that retirees should take less risk in their portfolios. But I just can’t bring myself to buy any bonds.

We’ve always been able to handle the risk of stocks in the past. 2008 was scary, but we didn’t sell low. If we can handle the risk of stocks, shouldn’t we use them because of their higher returns? Is it crazy not to own any bonds even in retirement?”

As we’ve discussed in the past, your asset allocation should be determined by your risk tolerance. And your risk tolerance, in turn, is determined by two factors:

  1. How emotionally/psychologically comfortable you are with volatility, and
  2. How much risk you can actually afford to take with your money.

Emotional Risk Tolerance

If you’ve had a 100%-stock portfolio through your entire investing career and haven’t ever bailed out of the market during downturns, then you have very good evidence that your emotional risk tolerance is high — far higher than most people’s.

That said, I’ve heard from many retirees who found that their emotional tolerance for volatility fell through the floor on the day they retired. They found that a portfolio decline feels quite different once the portfolio (as opposed to work income) is what’s paying the bills.

Economic Risk Tolerance

When it comes to assessing your economic risk tolerance, I think a good test is to calculate what percentage of your portfolio you have to liquidate each year to pay for expenses.

For example, if your Social Security (and pension, if applicable) cover your most important expenses, then you can get by without spending anything from your portfolio, which would mean you have a very high economic risk tolerance. That is, you could afford to take on as much (or as little) risk as you want with your portfolio without having to worry about financial ruin.

And a similar thing can be said for withdrawal rates that, while greater than zero, are still very low. For example, if your annual expenses (after subtracting pension and Social Security income) are equal to just 1-2% of your portfolio balance, you can probably get away with a super aggressive portfolio, a super conservative portfolio, or anywhere in between.

But when we start to get to withdrawal rates of 3%, 4%, or 5%, the economic risk of a 100% stock portfolio starts to show up. Historically speaking, for withdrawal rates in that range, 100% stocks has a higher probability of portfolio depletion than a middle-of-the-road portfolio.

Of course, with interest rates as low as they are right now, the bond portion of most retirement portfolios is likely to contribute a lesser amount of return than it has in the past. Still, it’s worth noting that for a normal length retirement using a 3-4% starting withdrawal rate, the biggest risk is not a period of low returns (such as those you’re likely to get from bonds right now), but rather a big loss early in retirement (which is the kind of thing that’s more likely to happen with a very stock-heavy portfolio).

If that last statement is confusing, consider an investor using a 3.33% initial withdrawal rate that’s adjusted upward each year in keeping with inflation. If the investor’s portfolio just matches inflation each year (i.e., earns a 0% real return), his/her money will last for 30 years, which is slightly longer than the typical retirement.

In other words, for modest withdrawal rates, you don’t need super high returns. For the most part, you just need to avoid the scenarios in which regular spending coupled with a severe market decline causes a portfolio drawdown early in retirement from which you cannot recover.

In short, under certain (uncommon) circumstances, a 100%-stock portfolio could make sense in retirement, but it’s important to understand that:

  • Emotional risk tolerance often declines sharply upon retirement, and
  • If you’re using a withdrawal rate in the 3-5% range, going all-in on stocks probably makes it more likely that you’ll run out of money, even if your emotional risk tolerance is absolutely ironclad.

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  1. It makes little sense to invest in bonds in the current environment. The reward (interest) is at record lows, and the risk (price) is at record highs. With that said, 100% in stocks is too aggressive, especially for someone 5-10 years from retirement.
    The most hated asset category today is cash. Now is a great time to take some profits out of equities and put into cash (even at near zero rates). Cash has a zero correlation to other investments, provides protection in down markets, and provides capital for future investment when bargains become available.

  2. Both Wade Pfau’s charts and the Trinity Study show that 100% stocks gives the best probability of success if you plan to use a large withdrawal rate.

  3. Petunia,

    Yes, that’s an important observation. With a high withdrawal rate, the only chance for success is to load up on stocks and hope to win the high-returns-early-in-retirement jackpot.

  4. Just because it has worked up to this point doesn’t mean it’s the right thing to do. They have a long life ahead of them and losing a large chunk of their portfolio would be catestrophic to their future. Just for safety sake why not move investments to more diversified and safer places. Treasuries, rental property, bonds, etc.
    I would be worried with just stocks in my portfolio.

  5. I hear a lot about the danger of a significant loss near the beginning of retirement’s draw-down phase. The bit about “near the beginning” always seemed a bit odd to me. Once you have entered the draw-down phase, isn’t it ALWAYS *exactly* at the beginning of the *rest* of your draw-down phase?

    It seems to me that ANY significant loss can be tragic at ANY time during retirement.

  6. Bob,

    It’s due to the math that occurs when you’re mixing addition/subtraction with multiplication. To illustrate let’s compare two different scenarios.

    Scenario 1: You have a $5,000 lump sum right now, and you know you’re going to spend it, all at once, five years from now. In this case, the order of the returns you experience over those five years doesn’t matter. We’re dealing with the “commutative property of multiplication” here, which tells us that when you’re multiplying a bunch of numbers, the order in which you place them does not matter (e.g., 3 x 4 x 5 gives the same result as 5 x 4 x 3).

    Scenario 2: You’re investing $1,000 at the beginning of each year, for five years. At the end of those five years, you will spend the money. In this case, the order of returns does matter. For example, the return earned in year 1 matters the least, because it only affects $1,000, and the return earned in year 5 matters the most, because it occurs after all the $1,000 additions have been done.

    This is why it’s intuitively obvious that the return earned, for example, between ages 22 and 23 by an investor who just managed to scrape together $400 to open her first Roth IRA isn’t terribly important. In contrast, it’s obviously very important what kind of returns the investor earns immediately before retirement, when her portfolio is far larger.

    The same analysis applies for retirement portfolios — it’s just flipped on its head. (That is, the returns that are mathematically most important are those that occur early in retirement before all the year-by-year subtractions occur.)

  7. Mike,

    That much I understand. I have three comments:

    1. Whatever math is used at the beginning of a retirement applies just as well at any given time during that retirement.

    2. At any given time, a loss at that time is *actual* but future losses are hypothetical. Actual is almost always more important than an equivalent hypothetical. This leads to the next comment …

    3. The measure of importance seems to be loosely defined. Yes, a significant loss is “important” at the beginning. Now add five or 10 years. To the person involved, a significant loss at that time could be just as important, depending on the size of the nest egg at that time. Perhaps this is almost the same as number 1, above.

    Just some very loose ideas that run through my head whenever I hear that it is more devastating to lose money early in retirement than later. Perhaps the answer is, that if it occurs late enough it doesn’t matter at all! (Unless you are desirous of a legacy.)


  8. re my post just above: In summary, after you add five or ten years, you are now at a *new* beginning and everything applies all over again.

    I guess in other words, any immediate loss is more important than future losses but at any given time, anything that happens is immediate.

  9. Bob,

    You wrote, “The measure of importance seems to be loosely defined.”

    In this case, “importance” means “impact on probability of running out of money.”

    You wrote, “Perhaps the answer is, that if it occurs late enough it doesn’t matter at all!”

    Yes, this is it — more or less. Often, toward the later part of retirement, the outcome has already been (mostly) determined.

  10. Bob, I think the difference is that someone who is recently retired might have a 30 year time horizon (ie to age 95). A big drop in the portfolio value at that time will increase the odds of running out of money by a certain amount.

    If you fast forward 10 years, there is then only a 20 year time horizon and a similar portfolio drop at that time will increase the odds of running out of money, but the drop will be less than in the 30 year example.

    In other words, the shorter the time horizon, the less sensitivity to portfolio drops.

  11. I don’t think there’s any reason to be anywhere close to 100% stocks 5-10 years from retirement. In fact, as Ken mentioned above holding cash is not a bad idea right now since bond returns are so low and the risk is going up. Aren’t cities going bankrupt these days(Stockton, others)?

  12. Interesting subject. One of the things I seem to be finding is, if you start with all stocks, and then want to back off to reduce the risk of running out of money, if you use SPIAs rather than bonds, you may do much better. You also need to look at a different downside measure–rather than just probability of depleting savings, you need to also consider how bad things are if you do run out of money. Building in a SPIA layer makes the downside less dire. I use a measure = probability of depleting savings times average loss (like a negative bequest) which is a simple measure that takes both magnitude and probability into account. We may find that, although stock/bond mixes make sense for the accumulation years, Stock/SPIA mixes make more sense for the decumulation years–quite a change from the way we have been looking at it.

  13. Bob, I believe you are spot on. Once in retirement reverse dollar cost averaging rears its ugly head. Added to a declining market at the same time and it could significantly negatively impact their ability to have enough for the later years. One prudent approach would be to subtract SS and any pension from their actual cost of living and put an amount into an annuity to cover the difference. The remainder could be put 100% into stocks. This would allow continued growth while minimizing the potential for a catastrophic loss happening. Grandma was right about putting all your eggs in one basket! -Ed

  14. I’ve always been a firm believer in having at least 10% bonds regardless of risk tollerance and at least 10% stocks regardless of risk aversion.

    Neverless my grandpa is in the same boat and invests 100% in stocks.

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