How Much Stock Is Too Much in Retirement?

The stock market can provide eye-popping term returns but can also be counted on to produce big losses. High-quality bonds, on the other hand, typically generate modest returns but are better for income and relative stability.

So buy stocks for the long run, but as you age and get closer to the moment when you will need to rely on your nest egg, shift gradually into bonds and hold less stock.

These may seem to be truisms, and they are embedded in the design of target-date funds, the diversified stock-and-bond portfolios that received government approval to be the default offering in corporate retirement plans in 2007 and have quietly become central all-in-one pillars of investment for many Americans. While the ideas reflected in these funds may seem obvious, they are not settled doctrine in academic finance, and they certainly don’t hold true for all people all of the time.

Still, with the demise of most traditional pensions — known as defined-benefit plans — and the limited, though crucial, capacity of Social Security to ensure a comfortable retirement, people need to invest for themselves. With the blessing of the U.S. government, target-date funds and trusts have become an enormously important way of doing so. Once you choose a fund, you can “set it and forget it.” The fund company does the rest for you.

About $3.1 trillion was invested in them through October, according to data from the Investment Company Institute, a trade group for the mutual fund industry, and Morningstar, a financial research company.

In a shift that is just beginning to be offered to workplace retirement plans, Vanguard, which has dominated the target-date fund market, has begun to acknowledge the need for variations in its standard portfolios for retirees.

It now says that some investors who have already entered retirement may be better off if they keep their stock holdings fairly high, retaining a 50 percent allocation to equities. The 50 percent stock retirement portfolio will be a new option available to companies with Vanguard target-date retirement funds in their plans. That is a big increase over the current allocation: just 30 percent stocks and 70 percent bonds.

“People will need to evaluate this at a household level,” Roger Aliaga-Diaz, chief economist for the Americas and head of portfolio construction at Vanguard, said in an interview. “This greater allocation to stocks would be for people with more willingness to take on more risk, who are more comfortable with an inherently more volatile portfolio and who are wealthy enough to have the ability to take on more risk without endangering their retirement.”

Like the target-date funds of other leading companies, including Fidelity, BlackRock, T. Rowe Price, and JPMorgan, Vanguard’s offerings have kept things simple for investors until now.

Look under the hood, though, and you’ll find that Vanguard’s target-date funds are actually a collection of low-cost, broad-based index funds, with holdings in a variety of domestic and international stocks and bonds. For large workplace plans, these investments are not mutual funds but, technically, collective index trusts, which are generally cheaper than mutual funds, with pricing negotiated with individual companies. (For example, the standard Vanguard Target Retirement 2030 Fund has an expense ratio of 0.14 percent, which Vanguard will lower to about 0.08 percent in February. That compares with 0.065 percent in expenses for the equivalent offering in The New York Times 401(k) plans.)

Until now, you could disregard the strategies powering the funds. All you had to do was decide which target-date fund most closely matched your likely retirement date — they are categorized in five-year increments, ranging, at the moment, from 2015 to 2065, with the 2070 fund emerging shortly — and Vanguard would make adjustments for you gradually as you approached retirement. The Vanguard Target Retirement 2065 Fund, for example, contains more than 90 percent stock and less than 10 percent bonds.

The funds attain a 50 percent stock allocation at the designated target date, say 2030, and for seven years, the allocation declines until it reaches 30 percent in the Vanguard Target Retirement Income Fund for retired investors. That’s the current setup, which will continue to be the default in workplace plans.

But this year, Vanguard is introducing a new fund, the Vanguard Target Retirement Income and Growth Trust. At the target date, a retiree’s investments would flow into that fund, which will never drop its equity proportion below 50 percent, Nathan Zahm, head of goal-based investing research at Vanguard, said in an interview. “This fund is right for some people, those who can handle more risk and can afford to do so,” he said. “But people will need to think carefully about it.”

The company’s research shows how the two different equity allocations would have affected a retiree with a portfolio of $1 million from 1990 to 2020, based on the performance of the markets tracked by the indexes represented in Vanguard’s current array of funds. The 50 percent stock fund would have had annualized returns of 7.3 percent versus 6.6 percent for the 30 percent stock fund. That amounts to $7,000 extra each year for the fund with more stock, which the retiree could have spent or salted away.

But the greater risks associated with stock investing were also apparent. The biggest loss in any 12-month period for the fund with more stock was 28 percent, compared with 17 percent for the traditional income fund. If those declines occurred in the first year of investing, the $1 million portfolio would have had a whopping loss of $280,000 compared with a $170,000 decline for the bond-heavy fund. Clearly, unless you are capable of withstanding the greater loss, you should not risk the 50 percent stock fund.

It’s easy to contemplate hefty stock investments when the market has risen for years. But if you need to stop working just as the stock market falls — which happened to many people in 2008, when the S&P 500 dropped more than 38 percent — target-retirement funds will generate painful losses with either allocation.

That’s why some finance experts are skeptical about trusting such a big part of the nation’s retirement to target-date funds. Zvi Bodie, professor emeritus in finance at Boston University, and the author of numerous books on investing, said in an interview that target-date funds fail to perform a crucial task: ensuring that people who save their money will have a secure retirement.

“The risk of owning stock never goes away,” he said. “It’s an illusion to think it will.”

For a core investment, he recommends buying U.S. government inflation bonds, or I bonds, which are now paying an interest rate of more than 7 percent. And he favors purchasing lifetime insurance contracts, also known as annuities, which, he says, “are unpopular but will guarantee that you have enough to live on.”

Adding stock to a retiree’s portfolio may be fine if, for example, you have a pension that you can count on or have otherwise taken care of your income needs. Otherwise, he said, “It’s not what I’d suggest.”

I’ve been investing in target-date funds for years and appreciate their virtues of simplicity and automatic rebalancing.But I’d have to think carefully before putting extra money into stocks. If market history tells us anything, it is that there will almost certainly be big shocks down the road.