Unless you’re fabulously wealthy, retirement planning is a tightrope walk between two risks. Take too many gambles and you risk a big loss on the eve of retiring. Invest too conservatively and your money might not be there to grow old with you.
The stock-market collapse of 2008 was a strong reminder of the first risk. Anyone who retired with a big stock portfolio at the end of 2007 would have been thunderstruck by the losses over the next 15 months. It was bad enough to drive many people back to work – if they could get it. In fact, the Aughts have been pretty depressing for investors.
But is a conservative approach better? A new study by T. Rowe Price (Stock Quote: TROW) concludes it isn’t. The firm argues that the more aggressive, stock-laden portfolio will serve the investor better than a conservative one — despite the frightening moments. The more aggressive portfolio grows so much more during the good times, which are more common than bad ones, that the risk is worth the reward.
“Even with a sharp downturn in stocks at retirement, an investor who had a high allocation to equities for many years prior to retirement had the opportunity to accumulate more assets than an investor who had pursued a conservative allocation,” T. Rowe reports.
The study compares two hypothetical investors who planned to retire at the end of 2007 and withdrew their retirement savings in three equal installments on Jan. 1 of 2008, 2009 and 2010—the same thing an investor does to to provide retirement income.
The calculations assume that 30 years earlier each investor had 90% of the retirement portfolio in stocks. Each earned $50,000 a year, started with $10,000 in savings and invested 7% of his income in the Standard & Poor’s 500, thereby increasing the sum 3% a year to counter inflation.
The aggressive investor reduced his stock allocation by 1.32% a year so it reached 50% at retirement at age 65, then reduced stocks by 1% a year for the next 30 years, ending with 20% in stocks at age 95. The conservative investor reduced the stock portion by 2.32% a year to reach 20% at age 65, then kept a 20% stock allocation for the next 30 years.