Retirement Risk, Rising Equity Glidepaths, and Valuation-Based Asset Allocation

Michael E. Kitces

The Kitces Report & Nerd’s Eye View; Pinnacle Advisory Group

Wade D. Pfau

The American College


This research investigates two types of dynamic asset allocation strategies (predetermined equity glidepaths and valuation-based asset allocation) for retirees using U.S. historical data. We analyze fixed asset allocations, traditional declining equity glidepaths, rising equity glidepaths, accelerated traditional and rising glidepaths, valuation-based allocations tethered around a fixed allocation, and glidepaths with valuation-based overlays. With U.S. historical data, it is difficult to beat a strategy which maintains a consistently high allocation to stocks (especially as measured by terminal median wealth), to the extent that a retiree’s risk tolerance allows for this, and subject to the caveat that high stock allocations cannot always be expected to do as well in the future. However, when we consider retirements beginning in varying valuation environments (as defined by the level of Robert Shiller’s cyclically-adjusted price-earnings ratio relative to its then-current historical median), we find the potential for different dynamic allocation strategies to help retirees sustain higher spending levels with lower average stock allocations in certain situations. When retirements begin in overvalued market environments (which reflects the situation for new retirees today), an accelerated rising equity glidepath has shown much potential to provide downside risk protection for retirees by minimizing equity exposure when an adverse market event would have the greatest impact. In other valuation environments, historical worst-case scenario sustainable withdrawal rates were highest with valuation-based asset allocation strategies, which maintain a midrange average stock allocation but adjust higher or lower when markets are deemed undervalued or overvalued, respectively.

Retirement Risk, Rising Equity Glidepaths, and Valuation-Based Asset Allocation: Introduction

This study explores the interaction of two research threads relating to asset allocation in retirement, examining whether the optimal equity glidepath should rise or fall throughout retirement (and at what pace those changes should occur), and/or whether retirement asset allocation should move up-and-down dynamically in response to stock market valuation extremes.

The first research area relates to the appropriate default equity glidepath for client portfolios during the retirement phase of the lifecycle. The conventional wisdom is that retirees should use a declining equity glidepath during retirement (e.g., where equity exposure glides downward every year as the client gets older). However, Bengen (1996) and Blanchett (2007) both found that static fixed allocations support higher sustainable withdrawal rates than declining equity glidepaths, casting at least part of the conventional wisdom into doubt. Neither tested rising equity glidepaths.

In turn, Pfau and Kitces (2014) found that rising equity glidepaths in retirement – where the portfolio starts out conservative and becomes more aggressive as retirement progresses – have the potential to modestly reduce both the probability of failure and the magnitude of failure for retirees relative to a static portfolio or a declining equity glidepath. This result may appear counterintuitive from the traditional perspective that equity exposure should decrease throughout retirement as the retiree’s time horizon (and life expectancy) shrinks and mortality looms. Yet the conclusion is actually entirely logical when viewed from the perspective of what scenarios cause a client’s retirement to “fail” in the first place (at least when the starting spending rate is modest). In scenarios that threaten retirement sustainability – e.g., an extended period of poor returns in early

retirement – a declining equity exposure over time will lead the retiree to have less invested in stocks if/when mean reversion takes hold and “the good returns” finally arrive later in retirement (assuming that the entire retirement period does not experience continuing poor returns). With a rising equity glidepath (that starts more conservative), the retiree is less exposed to losses when most vulnerable. This will work especially well if there is mean reversion in asset returns, and Blanchett, Finke, and Pfau (2013) provided empirical evidence that mean reversion is observable in a sample of 20 countries using financial market data since 1900. The equity exposure is greater as subsequent mean reversion effects may occur (i.e., when the good returns finally show up).

Asset Allocation

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