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By Christine Benz | 09-28-2016 05:00 PM

Why Some Retirees Have High Stock Stakes

Pensions, legacy planning, and a bull market have led to higher equity allocations for self-directed IRA investors, says Vanguard's Maria Bruno.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Research firm Vanguard indicates that many investors are maintaining high equity allocations well into retirement. I recently sat down with Vanguard senior investment analyst Maria Bruno to discuss that research.

Maria, thank you so much for being here.

Maria Bruno: Thank you, Christine.

Benz: You had a blog post recently where you examined equity allocations for older adults. And I thought there were some really interesting findings there. Specifically, you looked at IRA accounts of Vanguard account-holders and you compared them to the glide paths to the asset allocations that appear in Vanguard's target series. So, let's talk about how those self-directed IRA investors were allocating their assets relative to Vanguard's own created glide paths.

Bruno: Sure. I think it's a very interesting topic, and what we did in our research series is we were trying to look at investor trends. And what we did specifically with this research was we looked at equity allocations across the spectrum, and we used our target retirement glide path as a proxy. And what we found was that people at retirement at age 65, for example, were balanced at about 60% equity. While that wasn't surprising and actually, to me, it was very encouraging, because when you think about sustainable spending rules, for instance, as we both talk about quite frequently, it is predicated upon a balanced portfolio. So, I thought that was really a good news story. What was interesting though was that throughout retirement the retirees didn't seem to derisk, so they maintained that equity exposure throughout retirement as opposed to the notion of moving more conservatively throughout retirement, which is specifically the design of our target retirement fund as well as others in the industry.

Benz: So that equity allocation within the target series steps down once you enter retirement and eventually goes down to, what, like 30%?

Bruno: At Vanguard, it does, yes. And really when you think about how target-date products are built, the assumption is that retirees are using that account to live off of during their retirement. So their primary goal is to spend from that account for the portfolio durability looking at a time period of 30 to 35 years and making sure that there is a good chance that the portfolio will endure throughout that period. So it does make sense to have a balanced portfolio and then gradually move more conservatively over time.

Benz: So let's step back and talk about why some retirees when left to their own devices maybe maintaining more aggressive equity allocation throughout retirement. Maybe you might guess that we've just had a good equity market. One thing we see is that investors oftentimes just like to let their winners ride. Is there that possibility that perhaps some retirees are just a little bit inert when it comes to managing their portfolios, that they are just letting the good times roll?

Bruno: Yeah, it is interesting because when I posted the blog, we've received several hundred comments from retirees, which was fascinating, because everyone really thinks about it in their own particular situation and has their particular reasons in terms of why they are doing this. Central themes did pull through. Some of them were not surprising. I will preface this by saying these are IRA accounts here at Vanguard. So we know what we know in terms of data. These are Vanguard IRA investors. So they are tax-advantaged accounts. So the decision-making within taxable accounts could be different, but some of the comments that I have seen are just raised from an overall asset allocation standpoint, so you can think a little bit more broadly.

The other thing I will add too is that when we looked at Vanguard IRA investors, we also overlaid that with what we were seeing in the industry in terms of the Investment Company Institute, for instance, does some research at the industry level and the asset allocation trends are pretty consistent. So Vanguard investors, at least in their IRAs are not unique in terms of investor trends.

So then it would lead to why, and as you had mentioned a few of the reasons, one of the things that had jumped out was that a number of retirees still have pension, so they have this guaranteed income source in addition to Social Security. So they are thinking about this fixed-income stream as a bondlike asset. So with this guaranteed income that lasts throughout retirement and in the case of Social Security, increases with inflation, they may be able to take more risk within their overall investment portfolio because they might have a fraction of their baseline expenses met by these guaranteed income streams. So that was intuitive. That wasn't necessarily surprising.

Benz: Would you argue that if someone does have that big pension that they are bringing into retirement that that does in fact call for a higher equity allocation in most instances?

Bruno: Well, it can, Christine. When you think about how retirees think about that remaining portfolio, so if their baseline expenses are being met by their pension and Social Security, for instance, they may not need to spend from their portfolios. So their goals maybe different for that portfolio, and it may actually warrant a more aggressive asset allocation. That is very reasonable, yes.

Benz: And in terms of multiple goals that a retiree might have, let's talk about some of those. So in addition to just meeting my regular income needs, what would be some of the other goals that retirees would be shooting for and how would those influence their asset allocation?

Bruno: The big one really is legacy planning and wealth transfer. So, for more affluent retirees, they may be thinking about their tax-advantaged accounts as a way to transfer wealth. You'll see this more particularly with Roth and in fact, I did get a lot of reader comments about this as well in terms of looking at Roths and taking the advantage of the fact that you don't need to take lifetime distributions and those assets can pass income-tax free. So maybe allocating those toward later in retirement, so to take advantage of the tax-free growth or to use those as assets to pass to beneficiaries as well. And in fact, what we did see was that there was a higher equity allocation within Roth. So I think there was about 70% in equities throughout retirement.

Benz: So Roths as compared to traditional IRAs you saw even higher equity allocations there.

Bruno: We did, yes. And again, I don't think that's surprising when I think about how investors may view their Roths, and if they are using these to pass assets to their children or grandchildren, they're taking advantage of that tax-free growth with higher equity allocation. So that again is intuitive, and I wasn't surprised by that.

A couple of the other things that we had seen in terms of reader comments which were some of the things that I had thought about too was that one, investors may not be rebalancing. So we've had a very rich bull market, so equity allocations are rising. Investors may have some level of inertia and not rebalance. It does concern me a bit because if we do have a market correction, retirees may not be comfortable with the volatility that they may see if they haven't really thought about their equity allocation. I think that's the one piece that concerned me.

The other thing that I really saw in the comments and again, I had thought about this as well, is that investors generally are worried about where to invest, particularly on the bond side. So with interest rates being so low and the concern around interest rates going up and what the potential there might be to their overall bond portfolio, they are hesitant to potentially rebalance or go into bonds. But again, the bonds play a role in the portfolio, and it's very important to maintain that right balance.

Benz: A related question is, and I guess, without doing more digging it might be difficult to answer this, but does it seem to you that some retirees in lieu of bonds are looking more to dividend-paying equities to help provide that stream of income in retirement? Is that possibly in the mix, too?

Bruno: It is, and that's typically what we see in a low interest-rate environment where investors may be trying to alter their portfolio to try to get higher yields, so it could be dividend-paying stocks; it could be overweight in credit within their bond portfolios. I can't stress enough that that does come with a risk because when we do have some market corrections, these types of investments tend to be more equitylike than bondlike. So the risk mitigation within investment-grade diversified bond holding is not necessarily going to be there at a moment when you need it. So, yes, that is a concern that investors can get overly concentrated in dividend-oriented securities.

Benz: Final question for you, Maria. What about the all-in-one funds and to what extent would those potentially influence retirees' allocation? So, if my big holding is, say, Vanguard Wellington or a Balanced Index of something like that, that would tend to hold my equity allocations somewhat steady if I were using that as my main or even only holding, right? Could that be influential here, too?

Bruno: It can. When you think about investing in tax-advantaged accounts, balanced products, whether they are a target-date fund or a target risk fund such as Wellington that you had mentioned, very suitable products. They do the portfolio management for you as an investor. So really you don't have to worry about that piece of it. So that does take away some of the concerns around not rebalancing and potentially over-concentrating a portfolio. So retirees generally will have holdings when they enter retirement. They may not be able to unwind that, and that's perfectly fine. It's just how it fits into the overall asset allocation.

I also saw some comments around taxable assets. So, while we looked IRA holdings, a number of retirees have built wealth in their taxable accounts, particularly higher-net-worth individuals, so that's not surprising, and they may have gains in those portfolios and it may be difficult to unwind those or they may be working with their tax advisor, for instance, and doing smart strategies there too. So it really is a combination of the overall portfolio.

I do think that the message here on what we saw is that retirement for most individuals is really the focus of making sure they have enough assets to live through their retirement. But for many, it's a multigoal retirement given the complexities of their income streams and potentially their goals as well.

So target-date funds and the design is very prudent, and what we also see though is that it's a piece of the puzzle when we think about the retirees as a whole and how they think about their individual goals.

Benz: OK. Maria, interesting research. Thank you so much for being with us.

Bruno: Thank you. Thanks Christine.

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