Guided Retirement Income Planning- Chapter 14

Many plans need to last over 30 years. Stocks (equity) are the primary investment vehicles helping to maintain the longevity of your retirement plan. There are several approaches to determine how much equity should be held in a portfolio, and as with the retirement plan, there are many variables to be considered with portfolio construction. A well-customized retirement income portfolio will be well thought out and flexible for evolving needs and changing market conditions. Importantly, the portfolio design will reflect your risk tolerance and risk capacity (see Chapter 13).

Dynamic stock allocations not only promote growth and longevity for the plan, but mitigate the impact of inflation or simply put, the loss of purchasing power. It should be noted that short-term stock allocations are more susceptible to both market and sequence of returns risks. After you understand how much equity should be held in your portfolio, you will want to consider using a number of asset allocation strategies, some of which are itemized below:

1. Age-based asset allocation – In general, the stock allocations will vary with age and change over time; compares to target date funds often found in qualified retirement plans and 529 education accounts.
   
   
2.  Valuation-based asset allocation – Stock allocations will vary with market valuation levels. A couple examples: adjustments can be based on overall market P/E (price/earnings) ratios being overvalued or undervalued. Or, the year after a substantial market decline, stock allocations are increased, while the year after a substantial market gain, stock allocations are decreased.
   
   
3. Adaptive asset allocation – Stock allocations related to whether retirement is properly funded or whether the present value of assets can meet or exceed the present value of liabilities/spending. The stock allocation would be lower if the retirement portfolio is adequately funded. If a portfolio is overfunded or underfunded, for various reasons, equity positions could be higher. For example, if the plan is overfunded, one might choose to lower risk because the reward is unnecessary while another might choose to increase risk for greater wealth knowing there is a greater margin of error for the additional risk taken. Conversely, when a portfolio is underfunded, the investor is faced with the difficult decision of taking on more risk to meet needed returns (whether they have the appetite for greater risk or not).
   
   
4. Constant asset allocation – The allocation to equities does not change over time. Maintaining an acceptable level of portfolio performance variance (the volatility level) is important.
   
   
5. Volatility-based asset allocation – Realized or expected volatility defines the equity weighting of the portfolio.
   
   

When using these asset allocation approaches, independently or in combination with each other, it is essential to understand their risks and expected outcomes in different market environments.¹ You will want to assess your risk tolerance and understand your risk capacity (Chapter 13) so that you can decide on the right dynamic stock allocation(s) for you. Your personal risk tolerance and how well you follow the investment approach in your retirement income plan will be a primary factor in your success. Many risk tolerance questionnaires and software programs exist. Make sure you get this right and review it regularly.