Since my recent posts discussing my own asset allocation and my thoughts on Treasury bonds vs. Vanguard’s Total Bond Market Fund, I’ve gotten a steady stream of emails about asset allocation–especially for retirees or soon-to-be retirees.
That’s good. It’s an important topic.
But I think it might be helpful to back up and remind ourselves that asset allocation isn’t everything. For example, any of the following factors can play a larger role than asset allocation in determining how likely you are to run out of money during retirement:
- How long your retirement lasts,
- What withdrawal rate you use (including amounts paid for mutual fund expenses, brokerage commissions, or advisor fees as part of your withdrawal rate),
- What portion of your portfolio you choose to annuitize, and
- Whether or not you make any big mistakes (bailing out near a market bottom, for instance).
Withdrawal Rate and Length of Retirement
Acting in combination, length of retirement and withdrawal rate are the most important factors as to whether you outlive your money or vice versa.
For example, if you’re looking at an expected retirement length of just 10 years, and you can afford to (and plan to) use a withdrawal rate of just 3%, then regardless of what asset allocation you use, it’s almost impossible for you to run out of money.
On the other extreme end of the spectrum, if your retirement could end up lasting 30 years or more, and you’re looking at a starting withdrawal rate of 8%, that’s a problem. Before fiddling with your asset allocation, you need to find a way to retire later and/or reduce your level of spending.
It’s only in the middle range–the “maybe I have enough, maybe I don’t” range–that asset allocation comes to play an important role.
Annuitizing (a Portion of) Your Portfolio
Next in order of importance comes the decision of how much of your portfolio to annuitize. [Reminder: A lifetime immediate fixed annuity with inflation adjustments functions very much like a pension--the annuity provider (an insurance company) pays you a predictable amount of money every year until you die, at which point the money disappears.]
If you decide to annuitize enough of your portfolio to completely satisfy your basic spending needs, then you can afford to use either a high-risk or low-risk allocation with the remainder of your portfolio–neither choice puts you at risk of running out.
Finally, there’s the behavioral factor. You can choose an allocation that’s exactly perfect for your withdrawal rate and expected retirement length, but if you can’t stick to your allocation–specifically, if you bail out of stocks at a market low or go all-in on stocks at a market peak–you’re in for trouble. (That said, your likelihood of making mistakes may of course be impacted by your asset allocation.)
Covering All Your Bases
Asset allocation is important. But even the most well-researched, well-planned allocation can’t create a miracle, so be sure to tend to the other aspects of investment success as well:
- Keep your spending under control so that you can save enough during your working years and withdraw little enough during your retirement years.
- If you’re in the range where you’re not confident a typical stock/bond portfolio will be able to sustain the level of spending you’d like, consider annuitizing part of your portfolio.
- Stick to the plan. Don’t get fearful or greedy at the wrong time.