How Much Should You Allocate to Stocks As You Approach Retirement
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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I owe both a big apology and a big thank you. But first, I want to welcome all the new listeners. While I was out last month, the show broke into the iTunes Top 50, and I'm not exactly sure how to take that since I wasn't the one behind the microphone, but I will take it.

Anyhow, it's nice to see the show continue to grow. It's a signal to me that we're doing something well, and it really does give me the motivation to continue to get better and improve and just figure out how to add even more value to everybody listening.

Before I share more about my apology, I want to publicly thank Jeremy Schneider for doing such a fantastic job of guest hosting. He did five awesome episodes. The feedback I received was overwhelmingly positive, and it sounds like everyone really appreciated having a guest host today.

versus me replaying old episodes while I took a break. So I'm glad I gave that a shot. If you have any feedback for me or Jeremy, feel free to shoot me an email at podcast at youstaywealthy.com. And if you haven't already, be sure to check out Jeremy's popular Instagram account at Personal Finance Club and his investing community that he's built at personalfinanceclub.com.

Okay, as for my apology, we really got our wires crossed over here with Jeremy guest hosting last month on the show. As he shared, we even failed to count the number of Tuesdays in the month of July correctly. But we also had a mix up with the next few episodes here in August, and I will not be publishing a full length show until Tuesday, September 1st. So for that, I apologize. All I can say is that I promise to find a way to make it up to everybody.

With that being said, I'm not going to completely leave you hanging today. I received a great question from one of our listeners, Chris M., and I wanted to answer it for him on the show so everyone could benefit. If you've ever wondered how much you should allocate to stocks as you approach retirement and make that big transition, today's episode is for you.

Okay, so Chris emailed me and he asked about managing the risk of your investments as you move into retirement. And specifically, he said the following, in retirement, I may only need to withdraw three to 4% of my total balance each year because we both have pension benefits. Both him and his spouse have pension benefits.

Rather than moving our investments into bonds, is it too risky to simply keep everything in the low-cost S&P 500 index fund that we own?

So really good question. And there are really two things to highlight in my answer to Chris's question here. One is the issue of diversification and a home bias. And then number two, sequence of returns risk and a rising equity glide path. And so let me try to explain each of these in plain English, of course. So the first is fairly straightforward, right? And you've probably heard me talk about this on the show, but

Putting all of your money in the S&P 500, which is an index fund of only United States stocks, is a pretty concentrated bet. Now, as you might know, U.S. stocks have done very well over the last 10 years when compared to international stocks, for example.

The iShares S&P 500 ETF, the ticker is SPY, has returned about 133% since August of 2010. So the last 10 years, the S&P 500 ETF SPY has returned about 133%. Now on the flip side, the iShares IFA ETF, the ticker is I-E-F-A, this is an index fund that tracks developed international stocks,

it's only returned 26% during this same time period. So US stocks, about 133%, developed international stocks, 26%. Now, one might conclude that US stocks are better than international stocks. Look how well they've performed. But that's not always the case. We could easily see this flip-flop over the next 10 years. And I'm not going to make a prediction here. I don't know where stocks are going to go in the future, but

my best educated guess is that I would not expect the same trend to continue over a long period of time. At some point,

I would expect international stocks to start outperforming US stocks. Now, since I don't have a crystal ball and I don't know when that will happen, I advocate for investing in both of these asset classes and not trying to just pick one. And these are only two asset classes, but everything I just said also applies to asset classes like REITs, which are real estate investment trusts, emerging market stocks, small cap stocks, value-oriented companies, etc.

Proper diversification is wildly important, especially as you're gearing up for retirement and attempt to create a withdrawal plan that you can't outlive. I've recommended it before, but I highly suggest checking out the book, The Investment Answer by Gordon Murray. It's a super easy read. It's only about 120 or 130 pages or so. So check it out. It will talk more about diversification and how to build a portfolio and the academic rationale behind it.

If you want something a little bit more dense, and I mean really dense, check out Unconventional Success by David Swenson. Okay, so the first issue with Chris only owning the S&P 500 is, of course, diversification. The second risk, specifically, we call it the sequence of returns risk and a rising equity glide path, which is something we haven't really talked about yet on the show. It's

It's a big topic, and I promised to dedicate a whole show to both of these, both sequence of returns risk and a rising equity glide path. But for today, I'm going to keep it really high level. So sequence of returns risk is the danger that the timing of when a retirement investor begins taking withdrawals will have a negative impact on the overall rate of return. So

as a retirement investor gearing up for retirement, you're no longer contributing new capital to your accounts that can help offset losses. Your risk becomes much higher. If you start to withdraw money at the wrong time, let's say we go into a recession and you fail to take this risk into consideration, you could have some really big losses that are almost sometimes irrecoverable.

So if Chris only holds the S&P 500 index fund and U.S. stocks decline while he is also trying to withdraw money for retirement, he could do some serious long-term damage to his portfolio and his retirement success.

The last thing we want to be forced to do is to sell our investments while we're also withdrawing them while they're also at a loss. So we have to be really careful about diversification and concentration, especially when it comes to creating a withdrawal plan in retirement and not knowing what's going to happen to the market tomorrow or next week or next year.

Now, Chris might say something like, okay, well, if the S&P 500 or if US stocks go through a difficult time period, then I'll just wait for the S&P 500 to recover. I have some money in my emergency fund. I've got my pensions. I'll just wait for the S&P 500 to recover and I won't touch my portfolio.

However, we don't know how long that could take. Previous recessions are fairly short lived, right? 08-09 was really only about 18 months. But what if we have another lost decade where U.S. stocks are completely flat for 10 years?

What if international stocks do really, really well over that same time period and Chris misses out on those returns? So we have to be careful here, assuming that if the S&P 500 goes down or U.S. stocks go down, we can just simply wait it out for a year or two. That's not always the case. There are very long time periods, these lost decades where we don't see any returns at all.

So again, we don't have a crystal ball and therefore we just have to do our very best to navigate the risk that we face with the information that we have in front of us.

Now, the rule of thumb that most investors follow is to increase exposure to bonds as you get older, but that doesn't necessarily always hold true. And this is where a rising equity glide path comes into play. Again, this is a big topic and one that I will dedicate a whole show to, but here are the cliff notes.

Contrary to the rule of thumb I just spoke about of increasing exposure to bonds as you get older, we've all heard the own your age and bonds, right? Academic research has actually found that doing the opposite can actually help improve retirement success rates. Again, this is known as the rising equity glide path.

The approach is simply to take a very conservative approach with your investments, two to three years leading up to retirement, and then maintain that conservative approach two to three years into retirement as you settle in and make that transition. Those, let's say, five to seven years are some of the most vulnerable years in your entire investment and savings career. So we want to be really careful two to three years prior to retirement, and then those two to three years as we transition into retirement.

We want to navigate sequence of returns risk and enter into retirement with a lot of protection in our portfolio so we don't experience these irrecoverable damages. Once we're safely into retirement and we have a good plan in place for withdrawing money, a rising equity glide path says that we can actually start to systematically increase our exposure to stocks again. Notice I use the word systematically. So if you read the research,

To implement this, it's a slow, systematic change to the portfolio, slowly going from bonds to stocks. It doesn't happen overnight. We don't just all of a sudden make this change. We need to have a systematic plan in place to make these changes prudently and not just act on emotion.

So going back to Chris's question, he might want to be careful holding all U.S. stocks as he makes this big transition. I'm not saying that he should put everything in bonds, but bonds should probably be a part of his allocation as he approaches retirement and makes that transition. Just in case things get ugly and he needs to tap into his portfolio, not all of it is in one single asset class.

He should also think about diversifying outside of just U.S. stocks, as I previously talked about. International stocks, emerging market stocks, REITs, small cap stocks, value oriented companies, all these things are backed by academic research and are prudent in portfolio diversification.

With that diversified portfolio and that protection in there as he gears up for retirement, once he settles into retirement, you know, one, two, three years later, and he has a really good withdrawal plan in place, then he might consider implementing a rising equity glide path. It sounds like Chris is okay with taking some risk in his portfolio. Maybe he needs to take that risk, which leads me to my last point, which is,

There's this thing out there called risk capacity, and I've talked about it before, but risk capacity is very different than risk tolerance. Risk capacity is how much risk do you need to take in order to reach your goals safely?

So increasing exposure to stocks in retirement might have merit based on the academic research that's been done, but you might not need to take the extra risk in order to reach your goals. You might sleep better at night taking a more conservative approach, knowing that you're sacrificing higher rates of return over the long term, but that's okay.

On the flip side, maybe Chris needs to take more risk in order to reach his goals safely. Maybe he hasn't saved enough money. And sorry, Chris, I'm not making assumptions here. I'm just using it as an example. But maybe Chris hasn't saved enough money and he's forced to increase his exposure to stocks, even though it makes him a little bit uncomfortable. He might be forced to do that in retirement in order to create that retirement success.

So remember, there's this textbook answer and then there's your answer. So just because the academic research says one thing, you have to look in the mirror and ask yourself, do I need to implement that? How much risk do I personally need to take to reach my goals? Maybe it's less. Maybe taking a more conservative approach and sacrificing those higher rates of return matters most for you. So

I hope that was helpful. As always, shoot me an email at podcast at youstaywealthy.com if you have any questions. And I will see you back here on Tuesday, September 1st with something really fun to make up for the issue that we had with episodes this month. Thank you as always for listening. I'll see you back here in a few weeks.

This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services. ♪