Portfolio Design: A Modern Approach to Asset Allocation

CONCLUDING COMMENTS—POSTPONE RETIREMENT?

Americans are retiring in their early 60s and living long lives in retirement. Many of these Americans lack the luxury of a defined benefit plan providing them income in retirement. They might have accumulated wealth to carry them through the retirement years, but many do not understand how to invest that wealth and how to make sure that it lasts a lifetime. That’s why it is so important to address the issue of spending rules in retirement.

No set of simulations can give you a spending rule that is the correct one. So let’s summarize the key issues that those contemplating retirement must address. First, you need to focus on the risk that really matters in retirement, the risk of running out of money. Second, you need to base your spending rate on the returns you expect to earn on your portfolio after inflation has been taken out. Third, the spending rate has to be lower than the expected real, or inflation-adjusted, return because otherwise your risk of failure will be too high. Fourth, you have to recognize that we are not sure about what average real returns will be in the future, so we may have to be even more conservative than past returns would indicate.

If investors want to raise spending in retirement beyond the spending rules analyzed above, then it makes sense to annuitize some of the retirement portfolio. But there is one other suggestion that may make sense to investors—postpone retirement. The benefits of working a few more ...