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Retirement Planning: Beyond Asset Allocation

Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.

The financial industry puts considerable time, effort, and advertising dollars into showing Americans how to invest their retirement savings. Of course, wise investment of one’s hard-earned money is important. But the fact is that many Americans have saved very little for retirement. Actually, the typical person approaching retirement has less than $100,000 in his 401(k). Thus, for many people, even perfect investing is unlikely to have a significant effect on their well-being in retirement.

Fortunately, people have a number of other levers that can affect retirement security. And these strategies – unlike the stock market – are in the individual’s control: working longer, reducing consumption prior to retirement, and using a reverse mortgage to pull equity out of your home. We recently completed a paper here at Boston College’s Center for Retirement Research that shows the relative power of each of these alternatives compared to perfect asset allocation.

The benefits of each are numerous and not as obvious as they may appear. For example, people moving in on retirement age who decide to keep working can save more money, but the big financial boost comes from having to support fewer years as a retiree. And while many Americans rush to retire at age 62 – and those in physically strenuous jobs may have no choice – retirees can dramatically increase the size of their monthly Social Security check by working longer. If your Social Security statement says you’ll get $1,000 a month at age 62, keep reading: you’d get $1,760 by waiting until 70 to claim your benefit.

Reducing consumption levels prior to retirement can also smooth the glide path to a more financially secure retirement. That’s not easy for parents who, once their kids fly the coop, feel like it’s about time they live it up a bit – and they do. Empty-nesters spend about 50 percent more after their kids leave home. But spending less – not more – can make the transition to living on a fixed income in retirement less painful, while also generating extra cash to throw into the 401(k).

Many baby boomers have built up substantial wealth in their homes that they don’t use. Taking out a reverse mortgage, which unlocks the equity tied up in the family home, can provide significant additional income. Reverse mortgages are complex financial products that must be repaid when the retiree moves out of his primary residence or dies, so caution is recommended. They’re not very popular either with the public – but, if used right, they can boost retirement security significantly.

We compared the benefits of each of the three strategies just described with putting one’s entire retirement saving in “riskless equities,” a fictional asset that provided equity returns with none of the risks. That is, we gave asset allocation an unfair head start in the race to see which strategy was most effective.

Even with this head start, the results of our study showed that asset allocation always came in last in terms of effectiveness for improving retirement security for the population as a whole. It was slightly more helpful for those in the top 10 percent of the wealth distribution, but not much more.

A baby boom retirement crisis is unfolding. People need help. The danger is that help will come only in the form of asset allocation advice. In fact, people approaching retirement have much more effective strategies — working longer, controlling spending when the kids leave home, and taking out a reverse mortgage. People have options, they just need to know what they are and how they can help.


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    • The missing piece in this article is a general description of how to draw funds out of your IRA/401K accounts during retirement so that you don’t run out of money. There are 2 applicable topics here – the required roughly 3.33% annual withdrawl when you reach 70 and 1/2 years old and the bucket strategy organizing IRA/401K assets.

      The required withdrawl rate of 3.33% is calculated by dividing your IRA/401K assets by 30 assuming few people live past 100 years old. The bucket strategy is to divide up your IRA/401K assets into 3 (or more) buckets – one for each 10 years in retirement. The first bucket is filled with short term bond ladders holding money to be available for the first 10 years of retirement. The second bucket is a mix of some medium term bonds and very stable income producing stocks. The third bucket is filled with growth and income producing stocks that you do not need for 20 years.

      I read these recently and feel that they make a lot of sense. So I am sharing it with you all and see what others think of it.

    • A plan for retirement is critical and the idea of a reverse mortgage being a great vehicle, may be a little short sighted. Once the owner dies the house is then owned by the bank (or institution) who provided the instrument. For families and growing wealth through generations, that may not be the best option . ( In my opinion) I expected some more specifics in this article, but I appreciated it.

    • this is so broad and without details it is worthless. comeon wsj!

    • Those are valid points, but the struggle is how much to draw from accounts without running out. Longevity risk?

About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.