How to navigate the retirement danger zone

Retire well: How to not outlive your money
Retire well: How to not outlive your money

Are you prepared to enter the danger zone?

That's the time right around retirement when you have accumulated savings and are on the verge of drawing them down. A wrong move or a significant bear market at that point can have an outsized effect on your future financial life.

The question is, what constitutes a wrong move?

Many experts argue that those years are a time to pull in your horns and ratchet down the risk in your investments. "In the absence of guarantees," like a variable annuity allowing some withdrawals, "you probably want to reduce your exposure to equities as you get into retirement," said Srinivas Reddy, senior vice president and head of full service investments for Prudential Retirement. "You've got the biggest pot of money to worry about," since you now have a lifetime of savings that you are about to start using.

Prudential, which has actually trademarked the term "retirement red zone," sees a variety of risks, in part from people investing too aggressively to make up for lost time.

Anthony Webb, a senior research economist at the Center for Retirement Research at Boston College, also believes it is wise to reduce equity exposure as retirement nears. "There's less of a chance of losing money in the long run" with stocks, he said, since investors have more time to recover from market declines, but "there is more of a chance of losing a great deal of money" as retirement nears, since investors tend to be at their wealthiest point.

In addition, he said, young people have plenty of low-risk assets in the form of the present value of their future earnings, and relatively little to to invest, so they can afford to take more risk with the money they have. As people age, they tend to have less in the way of future earnings and more in the way of savings, so ratcheting down equity exposure to keep overall risk in check makes sense.

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But a growing number of experts are arguing for a different approach. Data from T. Rowe Price, for example, indicate that underexposure to stocks past a certain point can actually hurt performance and send investors into retirement with less money saved.

Investors "tend to spend a lot of time on how much is too much. We think they should also spend as much time thinking about how much is too little," said Jerome Clark, co-portfolio manager for T. Rowe Price's target date funds.

Clark and his colleagues compared a T. Rowe Price target date fund, with its 55 percent stock allocation at age 65, to an index of other target date funds, in which stocks account for 42.5 percent of assets for investors that age. From 1965 to the end of 2014, the firm found that its fund would have provided retirees with more money to draw down more than 99 percent of the time.

"There are risks associated with having too little in equities going into retirement," said Clark.

That is particularly important now because people retiring today may well live 30 years or more in retirement. A 65-year-old couple today has a 19 percent chance that at least one of them will live to at least 95, according to research by J.P.Morgan. (Tweet This)

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In addition, with interest rates currently so low, a significant exposure to fixed income carries its own risks. A Prudential study of retirement savings found that an extended period of low interest rates could increase the risk that a retiree would run out of money from 21 percent to 54 percent.

Low rates also mean that a pickup in inflation could quickly erode the value of even those reduced income streams. "There are a number of risk factors" that accompany so-called conservative investing, said Catherine Collinson, president of the Transamerica Center for Retirement Studies. "If you are too conservative, you risk having your savings eaten away by inflation. Inflation can be the enemy of the retirement nest egg."

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So what's an investor to do with all this conflicting advice?

One way to sift through the various recommendations is to think carefully about your investment time horizon and your tolerance for risk. If you expect to live in retirement for many years and you have a reasonable appetite for risk, it may make sense to put retirement assets into a low-cost annuity that guarantees some minimum income, and then consider how much of that portfolio you want in stocks.

Prudential's Reddy argues that when investors in retirement are out of the red zone and can protect themselves from the risk of too little income by investing in an annuity, a 60 percent equity exposure within that annuity structure is appropriate in retirement.

There is also a another way to steer clear of the retirement danger zone: Ease into your retirement. New T. Rowe Price research on retirement saving and spending behaviors found that 22 percent of retirees who retired with a rollover IRA or 401(k) were still working at least part time, and 22 percent of the people in that group were working as much or more than they were before. (Tweet This)

"I call it a shock absorber against market corrections," said Collinson. "You are still earning income, and maybe you don't have to draw down on a depressed value of your accounts in a correction."