Retirement Planning: It isn't Just about Age

12/06/2019 6:00 am EST


Landon Whaley

Editor, Gravitational Edge

Investing solely based on one’s proximity to retirement and not the broad economic environment is a mistake, writes Landon Whaley.

Last Saturday, I was enjoying my Saturday morning routine of firing up my brain cells with an espresso, while checking out Herbstreit and the boys on College Game Day when my best friend sent me an article entitled “Baby boomers are gambling their retirements with risky 401(k)s.” Now, I generally shut off my global macro brain on the weekend to recharge and come back strong on Monday, but I decided to give the article a once over. What began as a simple perusing quickly awoke the anti-Old Institution rage rhino inside of me, and I knew then and there that I had my next article.

Based on the latest quarterly study of retirement accounts in their custody, Fidelity shared some statistics that left me frustrated.

First, Fidelity found that out of 30 million retirement accounts, 53% of people contributing to 401(k)s and 66% of folks plowing money into a 403(b), have their retirement assets 100% invested in a target-date fund. For the uninitiated, a target-date fund is a type of mutual fund that rebalances asset class weights over time so that it’s more exposed to stocks when you are young (farther away from retirement) and gradually shifts towards bonds as you get older and closer to your retirement date.

Second, 23% of 401k investors have a higher equity allocation than is recommended for their age, and 7% of people contributing to 401ks have 100% of their retirement savings in equities! These stats get even more gnarly for baby boomers, where 38% have too much equity exposure, and 8% are 100% invested in stocks! Holy shmoly!

I’ve been in this game for nearly 20 years, and over that time I’ve seen a ton of outdated and dogmatic beliefs about the way markets work and the right way to invest.

You know the beliefs I’m talking about here. Notions like “diversification is good, concentration is bad,” “the stock markets always come back,” “old people should buy bonds, and young people should own stocks,” to name a few.

While I could teach an entire college course debunking popular market beliefs perpetuated by the Old Institution, the Fidelity data is screaming for us to have a conversation about the pervasive idea that your age should be a deciding factor in how you to allocate your assets.

Folks, I don’t care if your 16, 66, or 106 years old, the number one driver of all your investment decisions should be the prevailing Fundamental Gravity. Likewise, it doesn’t matter whether you are 50 years from retirement, 50 weeks or 50 minutes, you should be allocating your assets based on the prevailing Fundamental Gravity, because the FG drives the risk and return of markets, not your age or your retirement (target) date.

This “age-appropriate” approach to investing is born out of the common misconception that bonds are “safe” while stocks are “risky.” This adage is only accurate when the U.S. economy is experiencing a growth slowing regime, which is only half the time. Just so you don’t think I’m ranting and raving with no data to back me up, let's run through a retirement case study.

Let’s say its June 2016, and you are set to retire in December. First off, congratulations to you, you’ve worked your tail off, and your golden watch is just around the next corner!

Now, if you’re in a target-date fund or allocated based on the commonly held “age appropriateness” belief then you’re heavy on bonds, tilted towards Treasuries, and you’re light on stocks (or out entirely).

Why would you want to risk a drawdown when you’re this close to retirement? You wouldn’t, which is a fundamental flaw in this approach of the Old Institution.

the Old Institution prescriptions on asset allocation based on age is flawed. Here we explain why.

The problem with this allocation is that the prevailing Fundamental Gravity doesn’t give a flying blue monkey how old you are or when you’re punching your timecard for the last time.

In the summer of 2016, the U.S. economy is coming out of an industrial recession, growth is beginning to accelerate for the first time in 15 months, and the U.S. economy is solidly in a Spring Fundamental Gravity.

Your decision to overweight bonds because your adviser or the “gurus” on television told you equities was a kid’s game put your portfolio squarely in the drawdown crosshairs because all manner of bonds lost money over your last six months of work. Heck, even long-dated Treasuries got tattooed for a -14.6% cumulative decline in the second half of 2016 and experienced a near crashworthy drawdown of -17.9%!

How’s that for a retirement gift!

While bonds were getting the woodshed treatment, those “risky” stocks everyone told you to underweight or stayed away from entirely, they posted a 7.7% gain with just a 4.2% maximum peak-to-trough drawdown.

What you can’t know in December 2016 is that your portfolio pain is only just beginning because the economy is in the early stages of what will become the second-longest expansion in U.S. history!

From June 2016 (where our story began) through Sept. 28, 2018 (when U.S. growth peaked), the overweight bond allocation in our retiree’s age-appropriate portfolio declines 10.7% on a cumulative basis, with a 17.9% peak-to-trough move along the way. Said differently, owning bonds for those two years was a proposition where the reward-to-risk was skewed entirely in favor of the downside!

Not only did your bond allocation not make you money for 27 months, but it also dug you a hole.

While your bonds were bleeding your portfolio dry for over two years, the equities that you are underweight (or avoiding like the bubonic plague), gain 44.9% cumulatively (17.8% annualized) with just a 10.1% drawdown. That’s an impressive R-2-R of 4.4-to-1!

Let me say this loudly and succinctly: it doesn’t matter how old you are, no one can afford to go two years without making money, or to invest in asset classes with all downside and no upside.

I’m not cherry-picking with this 2016-2018 case study; the U.S. economy spends 47% of its time in growth accelerating regimes where it's more favorable to be in stocks than bonds, from both a risk and reward perspective.

That means the economy spends 57% of its time in growth slowing regimes, which favor bonds rather than stocks. We’ve been in just such a growth slowing regime since October 2018, and over that period, long-dated Treasuries are up +23.1% (with only a -8.2% drawdown) compared with the S&P 500 which has gained a decent +8.4% (all of it in the last five weeks), but suffered a -19.9% crash in route to that gain.

Which asset class would you have rather owned over the last 13 months? Is your answer different depending on your age? Heck no! Whether I’m a millennial or I’m on my way to the pasture, give me the asset class where the odds of success are skewed 3-to-1 in my favor, and I can earn more than +20% in just one year!

The retirement allocation bottom line is that you need to remove your age and your career timeline from the investing equation. Financial markets don’t care how old you are or how much longer you have before you retire to a beach to drink Mai Tais.

Financial markets, and more accurately, their risk and return characteristics, care about the trajectory of growth and inflation and how central banks respond to those economic conditions. Focus your efforts on keeping your portfolio aligned with the prevailing Fundamental Gravity, and whether you are a 20-something millennial or a 60-something baby boomer, you’ll consistently be positioned to minimize drawdowns and earn positive returns regardless of market conditions.

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This was originally posted during Thanksgiving week: We are reposting it in case you missed it.

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