Have you ever considered selling all your stocks or stock mutual funds when you retire? Who wants to have to deal with the ups and downs of the markets when you are no longer dollar-cost-averaging? Are you afraid of a major market crash when you are drawing down your portfolio?
The market is near its all-time high. With retirement right around the corner, are you tempted to sell all your stock holdings and call it a day? It might sound tempting. This market cannot keep going up, can it?
Every investor has the right to feel exactly how they feel about all of the scary things that are going on in the world. Don’t lose your head. The world has always been a volatile place and unfortunately, it always will be. If it is not one thing, it is something else.
Yes, it might be tempting to pull the trigger and sell high. You would walk away as a winner. Before you do that. Let’s look at how an all-bond portfolio might serve you in retirement.
For this exercise, let us assume that you are now sitting on $1,000,000 in your 401K. At retirement, you want to draw down 4% per year. How would an asset allocation of 100% in bonds hold up over the course of 30 years? To find out, I am going to run this test based on the Monte Carlo method by using the Vanguard Retirement Nest Egg Calculator.
There is a 69% chance that your savings will last 30 years. I do not like those odds. I especially do not like them for a person who retires early.
What about if a person wants that $1,000,000 to last 40 years? The percentages are getting much worse. There is now only a 36% chance that money will last 40 years.
Could you imagine going broke after being retired for 40 years? What would you do? Would you go back to work? Who would hire you at such an advanced age? Sure, employers cannot discriminate, but let’s be honest about the opportunities for someone who has been unemployed for that long.
What could an investor do to improve the chances of their savings lasting 30 years or even 40 years for those who enter early retirement? In Benjamin Graham’s book The Intelligent Investor, he gave a few suggestions for defensive investors. He suggests that a balanced portfolio made up of 50 in equities and 50% in bonds is a good place to start. He also suggested that an investor should never exceed an asset allocation of 75/25. In other words, an investor should never have more than 75% or less than 25% in equities or bonds.
I know that you are seriously considering selling your equity holdings and exchanging them for bonds. You have told yourself that you are finished with the market. Volatility is no longer for you. You want to enjoy your retirement without having to worry about how stocks are performing. If you do that, the odds are still not in your favor of not running out of money.
How would your $1,000,000 fair if you followed what the late Benjamin Graham suggested in his classic investment book? How would keeping only 25% in equities change the projected outcome? Would adding a more volatile asset class help or hurt the likely hood of running out of money?
By keeping 25% in equities, the percentages have dramatically improved. There is now a 78% chance that your money will not run out over the course of 30 years with a 4% drawdown rate. Over the course of 40 years, there is 57% chance that your money will last. By keeping 25% of the portfolio in stocks, there was an improvement of 9% over the course of 30 years and an improvement of 21% for 40 years.
Holding a small allocation of equities sure goes a long way. What about if you took it a step further and went with a mix of 50% in stocks and 50% in bonds? I know, I know. You are finished with stocks. Keeping 25% of your money in stocks is one thing, but going to 50% is just too aggressive for your retirement account.
I understand how you feel. You do not want to own stocks when the next recession occurs. A long stock market correction can be scary.
During a drawdown period, how does having 100% in bonds compare to an asset allocation of 50% in stocks and 50% in bonds? Over the course of 30 years, the 50/50 mix has an 85% chance of success. Over the course of 40 years, the 50/50 mix has a projected success rate of 74%. Compared to the portfolio made up of 100% in bonds, the 50/50 mix has a 16% better chance to not run out of money over the course of 30 years. For the period of 40 years, the 50/50 mix has a 38% better chance of not running out of money.
There are many factors to consider when selecting the asset allocation that is right for your retirement. How old will you be at the time of retirement? How long does your money have to last? How will RMDs impact your drawdown? What type of lifestyle do you want to live during retirement? Are you planning on leaving a legacy?
I am not trying to convince you on how you should allocate your portfolio during retirement. That is ultimately your decision. Everyone has a unique financial situation. The purpose of this post was to examine how different conservative portfolios might perform during the drawdown period. I am just trying to convince you to do your due diligence before you rush to any financial decisions that will impact your quality of life down the road.
After reviewing these results, it shows that diversification is still important during the drawdown period. Just as holding 100% in stocks is too aggressive for most investors during their working years, holding 100% in bonds might be too conservative for investors during the drawdown period. When an investor is working on building their wealth, holding a percentage of bonds helps to reduce the impact of how stock market volatility impacts a portfolio. During the drawdown period, holding a small percentage of equities greatly improves the likelihood of not running out of money in retirement.
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