My partner and Rebalance IRA co-founder Scott Puritz recently gave an interview to USA Today sure to raise the hackles of thousands of retirement advisers: The typical 60/40 stock-and-bond portfolio is fast becoming a problem for millions of American savers.
The idea, which dates back decades, is to hold about 60% of your retirement portfolio in stocks and about 40% in bonds. If stocks go up, you buy bonds to get back to 60/40. If bonds rise and stocks are stagnant, do the reverse.
“Those were not terribly bad rules a generation ago, but they’re now not just outdated but downright dangerous,” Puritz told the newspaper.
The billionaire investor Warren Buffett takes a similar, if extreme, view: Just own 90% stocks and do it cheaply using index funds. Now, a study from the IESE Business School in Barcelona suggests Buffett is on the right track.
According to the research,
a simple, cheap portfolio of 90% stocks and 10% bonds would only “fail,” meaning a retiree would run out of money, in 2.3% of cases. Financial advisers deem a portfolio with a 5% failure rate to be “low risk” for a retirement plan.
You might prefer zero risk, but consider all the factors at work here. You need growth to offset inflation, so cash is a nonstarter. Owning 100% stock would offer the highest growth, yet the risk of a market crash would give any retiree pause.
Using a 90/10 split creates a powerful “middle ground” between the best performance (100% stocks) and the best protection (a balanced mix of stocks and bonds), according to the study.
The takeaway for retirement investors is not “put it all into stocks” but instead focus on costs and consider how long you might live. Buffett prefers index funds for his heirs precisely because they take the cost factor down tenfold in a single move. Avoid pricey active management fees and you avoid a whole world of “cost risk” most people fail to recognize.
Some folks can follow Buffett’s advice, buy two index funds and go to sleep. Most people can’t, and shouldn’t. It’s one thing to prove a model in a backward-looking academic study. It’s another to live day-to-day with your investment choices.
That’s why at Rebalance IRA we recommend that our clients use six asset classes rather than two, rebalancing along the way. “There’s no sense in creating the optimal asset allocation that works at an intellectual level if when the markets drop, the investor can’t sleep at night,” Puritz told USA Today.
Buffett in Context
Nevertheless, we do agree wholeheartedly in the low-cost Buffett stock portfolio approach. For young people with decades ahead of them, a 100% stock portfolio is a real winner. Not because stocks only go up, but because a 25-year-old doesn’t have as much money on the table, so the ups and downs aren’t a cause for alarm.
That changes when people hit their 40s, but even then a 90% stock approach is workable.
When you get closer to retirement, that’s when we would suggest moving to something more like a 70/30 split, shifting down into a 50/50 model portfolio well into retirement.
Not just the S&P 500, though. A great stock portfolio will hold a wide variety of underlying investments, including small-cap stocks, dividend payers, foreign stocks and so on. Likewise, a well-diversified bond portfolio is not going to be a stack of Treasuries and that’s it.
You can own a diversified, sophisticated portfolio
at a low cost and you can rebalance it cheaply too, thanks to modern tools such as index-style ETFs. Ongoing, thoughtful financial guidance is the secret sauce that makes a portfolio work, helping to diminish an already-small failure rate in retirement.
is co-founder of retirement investment firm Rebalance IRA in Palo Alto, Calif. To read more Mitch Tuchman — Click Here Now.
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