It’s only natural for retirees to want to invest conservatively, but hunkering down with a super-safe portfolio of bonds and cash can actually boost their chances of outliving their money. As we explained in our last post, retirees should be able to preserve their nest egg for at least 30 years if they limit their annual withdrawals to 4% of their accounts. If you missed that post, here it is:
How much you can safely withdraw in retirement will depend heavily on what’s under your portfolio’s hood. An all-bond portfolio, for example, is less likely to provide staying power than a portfolio that includes stocks.
To reduce the chances of emptying your accounts prematurely, you have to accept some risk. That is, you have to find room in your portfolio for stocks.
While some retirees might consider stocks as appropriate as sticks of dynamite, what they often overlook is that many retirement accounts must keep chugging along for decades. And stocks, which are volatile, but also have historically generated higher returns, are more likely to provide greater mileage for your portfolio.
The Trinity Study, a landmark piece of research that is famous within the financial industry, illustrates the benefit of including stocks in a retirement portfolio.
You can see for yourself by looking at the table below that was pulled from the study that covered the period from 1926 to 1995. The portfolios with stocks lasted longer in many scenarios than those containing little to no equities.
The Trinity Study, which was conducted by three professors at Trinity University in San Antonio, TX, was updated in 2011 and the researchers concluded that retirees should consider limiting their inflation-adjusted withdrawals to 4% to 5% of their portfolio if their stock allocation is at least 50%.
While an all-bond portfolio would have lasted 30 years with a 4% withdrawal rate, the fixed-income portfolio would have experienced a 51% chance of surviving with a 5% withdrawal rate.
In contrast, a portfolio in the study containing 75% bonds and 25% stocks enjoyed a 100% chance of surviving when the withdrawal rate increased to 5%.
The researchers used the Standard & Poor’s 500 Index as a proxy for stocks and long-term high-grade domestic bonds for the fixed-income portfolio.
For a retiree, a portfolio containing stocks and bonds can provide both growth and stability. To get the most out of a mixed portfolio, it’s wise to use a strategy called total-return investing. That will be the subject of our next post.