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Are Target-Date Retirement Funds Doing Things Backward?

NEW YORK ( TheStreet) -- Financial advisers have long preached a cardinal rule: As you get older, shift your portfolio to more conservative assets.

The approach has influenced target-date mutual funds, which are used by millions of retirement investors. Using a typical target-date portfolio, a person in his 20s starts with an aggressive portfolio that has 80% of assets in risky stocks and 20% in safe bonds.

Over the years, the stock allocation declines gradually, following what is called a glide path. By the time the retiree reaches his 80s, the portfolio might have 20% in stocks and 80% in bonds.

The approach has satisfied many savers. But now some advisers are challenging the old dogma. The critics say that instead of reducing stock holdings, you should keep a static allocation, perhaps holding 50% of your assets in stocks for decades.

Some studies suggest that you would do better by starting with a low equity allocation and gradually raising it. So far, the critics have gained few followers. But their provocative studies present a challenge to traditional thinking.

Among the most compelling critics is Michael Kitces, research director of Pinnacle Advisory Group, a wealth-management firm. Kitces says that the greatest threat to a nest egg can occur when the market tanks just as a saver is beginning to take retirement withdrawals. If that happens, assets can be quickly exhausted.

Downturns that happen near the end of the retirement would not necessarily cause the saver to go broke. Kitces says that standard glide paths don't provide the best protection against crucial losses in the early years.

To understand his point, consider a hypothetical saver who retired in 2008 when many portfolios lost 40%. The saver started with 60% of assets in stocks and gradually lowered the allocation to 30% in the next 30 years.

If we assume that the market would deliver historic returns, the saver would likely have done better to move in the reverse direction, starting with 30% in stocks and gradually shifting to 60%.

The big allocation to bonds in the early years would have protected the portfolio during the downturn of 2008. Odds are good that subsequent rallies would benefit the portfolio as it gradually increased equity holdings.

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