Would-be centenarians should hold more stocks and tweak their Social Security timing, among other strategies.
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By Christine Benz | 05-08-14 | 06:00 AM | Email Article

A few years ago I attended the 100th birthday party for a family friend. Following a round of toasts and tributes, this never-married, lap-swimming centenarian treated her admirers to a rousing song-and-dance rendition of "Yankee Doodle Dandy." And she wasn't alone on the dais: Her older sister, a former member of the Women's Army Corps, joined her.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

These two are the only 100-year-olds I know, but they're not all that unusual any more. In fact, the number of centenarians in developed countries is increasing at a rate of more than 5% per year. At that pace, the population of individuals aged 100-plus will double every 13 years, according to the United Nations' World Population Aging Report.

Of course, it's still a fairly small subset of the population that will live that long--scare tactics from insurers and other financial-services providers notwithstanding. Just 5% of 65-year-old females and 3% of 65-year-old males will make it to age 100, according to Social Security actuarial estimates. But a much larger percentage--29% of 65-year-old males and 39% of 65-year-old females--are expected to live to age 90, according to Social Security statistics.

Such longevity is often cheered as an achievement, a tribute to individuals' gene pools, healthy lifestyle choices, and advances in health care. And rightfully so. But the downside of living well beyond one's average life expectancy is that it can strain--or worse, completely deplete--an individual's financial resources. With more baby boomers entering retirement without pensions--meaning that Social Security is likely to be their only source of guaranteed lifetime income--longevity gains heighten the risk that more individuals will outlive their investment assets.

The first step in addressing longevity risk is to evaluate just how great the odds are that either you or your spouse will have a much longer-than-average life span. Health considerations, family longevity history, employment choices, and income level may all be factors, as Morningstar's Adam Zoll discusses in this article. As Morningstar contributor Mark Miller notes in this article, 40% of adults underestimate their longevity by five or more years, according to a Society of Actuaries survey.

If you've assessed these considerations and are concerned about longevity risk--or if you've determined that you'd simply rather be safe than sorry--here are four key mistakes to avoid.

Mistake 1: Holding a Too-Conservative Portfolio
When investors think about reducing risk in their portfolios, they often set their sights on curtailing short-term volatility--the risk that their portfolios will lose 10% or even 20% in a given year. But a too-conservative portfolio--one that emphasizes cash and bonds at the expense of stocks--can actually enhance shortfall risk at the same time it's keeping a lid on short-term volatility. That's a particularly important point these days, given the fact that current yields tend to be a good predictor of returns from these asset classes. Not only are starting yields meager in absolute terms--the 10-year Treasury bond is yielding just 2.6% and certificate of deposit yields are barely more than 1% (if you're lucky)--but interest rates have much more room to move up than they do down. That will reduce the opportunity for bond-price appreciation during the next decade. With returns like that, retirees with too-safe portfolios may not even outearn the inflation rate over time.

That doesn't mean longevity-conscious retirees should jettison these safer investments, as they provide valuable ballast for the risky portions of a portfolio. It does, however, suggest, that those concerned about outliving their assets should shade their portfolios more toward equities than would be the typical prescription for people in that same age band. Morningstar's Lifetime Allocation Indexes provide model asset allocations for investors at various life stages with various risk tolerances. Those who think they're likely to live well beyond their average life expectancies would do well to veer toward the allocations for aggressive investors. That means an equity allocation of more than 50%, even for those getting close to and in the early stages of retirement. It also means healthy doses of foreign stocks as well as U.S. stocks (If you find your portfolio is extremely light on stocks right now relative to where you need to be, plan to build your positions gradually rather than dramatically increasing them all at once, as market valuations aren't what they once were.) 
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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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