Should retirees invest more in stocks or less?

A recent report from the American Institute for Economic Research (AIER) makes the case that as retirees age, they should increase the portion of retirement savings invested in stocks to as much as 70 percent.

This advice is contrary to conventional wisdom. For example, one common rule of thumb is that the target percentage of savings allocated to stocks should be 100 minus your age. So, if you're age 65, you should invest no more than 35 percent of your assets in stocks, with the balance in bonds, Treasury bills or cash.

Your asset allocation is a critical decision if you use systematic withdrawals to generate a retirement paycheck from your savings. With this method, you invest your savings in a portfolio consisting of stocks and fixed-income investments, and carefully select a method for calculating the amount of your monthly paycheck. Compared to other methods of generating income from savings, systematic withdrawals require the most ongoing attention from you (or your financial advisor).

Many popular balanced funds maintain a constant percentage of assets in stocks, from 40 percent to 70 percent depending on the fund's aggressiveness. William Bengen, who developed the popular 4 percent rule for systematic withdrawals, assumed that 50 percent of a retiree's assets would be allocated to stocks throughout retirement, although Bengen also studied strategies that devoted 75 percent to stocks. If you strictly follow Bengen's analyses, you'd maintain a constant percentage of assets in stocks throughout retirement.

Another popular retirement savings choice is target date funds, which reduce your exposure to stocks as you age. However, many such funds will allocate as much as 50 percent to stocks throughout your retirement years. Most target date funds are constructed by assuming you'll invest your savings to generate a retirement paycheck throughout your retirement, and they use systematic withdrawals to calculate that paycheck.

The assumption behind the conventional wisdom of reducing your exposure to stocks over time is that as you age, you have financially less tolerance for stock market downturns. But the AIER report gives two reasons for a rising allocation to stocks: First, as you draw down your savings, the amount of your monthly check will increase as a percentage of remaining savings. Second, as you age, income from guaranteed sources such as Social Security and pensions becomes relatively more important as sources of retirement income.

If you plan to use systematic withdrawals to generate your retirement paycheck and also use a target date fund, you should be aware of another point of view that advocates a low allocation to stocks upon retirement. The rationale is that a stock market crash right before your retirement, or soon thereafter, could derail your retirement plans.

It's entirely understandable if you're now less sure about the appropriate asset allocation for your savings in retirement.

So, here's one way to sleep better at night: Decide just how much retirement income you absolutely need to meet your basic living expenses, such as for food, shelter, utility costs and medical premiums. Then cover these expenses with guaranteed sources of retirement income, such as Social Security, pensions, systematic withdrawals invested in bonds or Treasury bills, bond ladders or immediate annuities.

This way, if the stock market crashes, you don't need to panic and move in with your kids. Then invest the remainder of your savings in stocks to cover your discretionary living expenses.

If you're not comfortable making decisions about generating a retirement paycheck from your savings, find a qualified financial advisor who has your best interests at heart and who you understand and trust. Although you'll find advisors with different opinions on the appropriate asset allocation in retirement, a trusted advisor can still help you make choices that are right for you.

You'll want to spend time developing a careful strategy for generating a retirement paycheck from your savings, and your asset allocation is a key component of that strategy. Given the decline of traditional pensions, this is mission-critical for many retirees.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Retirement Game-Changers: Strategies for a Healthy, Financially Secure and Fulfilling Long Life and Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck.