Asset allocation is an important part of investing—but it is not the most effective option to ensure financial security in retirement, according to the Center for Retirement Research at Boston College. Rather, other financial planning options are more influential in ensuring savings last throughout a retiree’s lifetime.
Researchers looked at replacement rates—the amount of money needed to replace an annual salary—and the ability of retirees to fully fund them. Thus, the focus was not on maximizing investment returns but on determining what someone could do to ensure their financial security in retirement. Four options were considered: working longer (delaying retirement to a later age), taking out a reverse mortgage, spending less and allocating completely to equities.
Delaying retirement had the biggest impact. This is because it boosts monthly Social Security payments, provides more time to contribute to retirement savings and shrinks the time period for which savings will be tapped. Delaying retirement from age 62 to 67 reduces the percentage of households age 60–70 that are at risk of running out of cash from 74% to 47%.
Taking out a reverse mortgage reduced the percent of households falling short by seven percentage points at age 62 and 11 percentage points at age 67. [Our take: Reverse mortgages have unique risks and costs, and they should not be used before other options are considered.]
Controlling spending reduced the number of household falling short by three percentage points at age 62 and six percentage points at age 67. There are other benefits, however. Cutting spending before retiring, particularly for households in their 50s, allows for more money to be contributed to retirement savings. In addition, the researchers pointed out that cutting spending well before retirement lowers the bar for projected day-to-day expenditures in retirement.
For measuring the effects of asset allocation, researchers assumed an all-stock portfolio with an annualized, riskless real return of 6.5%. These assumptions were made to maximize the impact of the allocation strategies. Yet the aggressive assumptions only reduced shortfalls by one percentage point at age 62 and three percentage points at age 67.
What the data shows is that investment strategies are not a panacea for inadequate financial planning. Maximizing retirement savings, working longer and controlling spending all play important roles in achieving retirement security.
Source: “How Important is Asset Allocation to Retirement Security?,” Alicia H. Munnell, Natalia Sergeyevna Orlova, and Anthony Webb, Center for Retirement Research at Boston College.