- Low rates on fixed income investments, longer lifespans and the desire to leave a legacy might be some of the reasons why older investors could increase stock exposure.
- An investor with a stream of guaranteed income — such as a pension or an annuity — could be better positioned to take equity risk and improve returns.
- Stocks are a smart choice for money earmarked for the future, but they shouldn’t make up the entire portfolio. Always keep cash for emergencies.
Staying in equities and embracing their risk and potential return just might make sense for some retirees.
Older investors with a combination of pension income, Social Security benefits and income annuities have a measure of safety in retirement.
"If you have a big pension and Social Security, maybe you have the ability to take more risk than you think," said Alex Brusda, chartered financial analyst and portfolio manager at North Star Asset Management. The Neenah, Wisconsin-based firm ranked fifth on the CNBC FA 100 list.
"Yes, short term they are risky, but as the time horizon increases, that market volatility goes down," he said.
"If you're saving in the long-term, knowing that might make clients more willing to own stocks and increase their allocation.
There are a number of reasons why it might make sense for a retiree to ramp up equity risk.
For instance, a judicious increase in stock allocation might be worth considering if low interest rates continue to drag down fixed income investments and fail to keep up with inflation.
"The outlook we have today is reasonably good, but forward-looking becomes more concerning for returns and risk," said Matthew A. Young, president and CEO of Richard C. Young & Co. Ltd.
The Naples, Florida-based firm ranked 10th on the CNBC FA 100 list.
"This is more fine-tuning versus going from 25% stocks to 65%," Young said.
Clients may also consider adding stocks if they plan on leaving a bequest once they die.
"If you want to give to a charity or give to your kids after you pass away, what you give will likely be more impactful if you give stocks," Brusda said. "You're getting more growth."
Just because an investor has enough income sources to absorb the risk doesn't necessarily mean that he or she is a good contender for higher equity allocation.
"The investor might understand greater returns, but they might not like the volatility," said Aram Schotts, a certified financial planner at Gamble Jones Investment Counsel in Pasadena, California. The firm ranked 12th among the FA 100 firms.
"Other investors might have the willingness, but they can't afford a 20% decline or worse," he said."
Rather than viewing Social Security and pensions as separate components of a client's portfolio, advisors should view them as components of the investor's overall fixed income allocation, according to Michael Finke, professor of wealth management at The American College of Financial Services.
Earlier this year, he released research that showed how a source of guaranteed income can take the pressure off an investor's portfolio.
Finke modeled out three hypothetical investors, each with $1 million saved.
Client A has only her $1 million portfolio. Meanwhile, Client B has the $1 million portfolio, plus a $20,000 income stream from her Social Security benefits.
Finally, Client C has $1 million in her portfolio, a $20,000 annual income stream from Social Security, and $30,000 annually from her pension.
Instead of viewing the investible assets and the Social Security income and pension as separate components, advisors should see them as part of one overall portfolio for the client.
That would mean estimating the portfolio value of the guaranteed income stream, be it Social Security or the pension, Finke explained.
Since the investor can count on receiving these sources of income each year, it makes them comparable to the fixed income portion of the client's holdings.
As a result, Client C, who has both a pension and Social Security, really has 72% of her wealth in bond-like investments, Finke said.
An investor with guaranteed income sources can take greater risk and add to her stock exposure.
"Guaranteed income is going to be smooth every year, so the consequences of investment volatility aren't as great," Finke said.
When it comes to adding equities, advisors must go beyond the balance sheet and perform an honest evaluation of that client's situation and her appetite for risk.
The prospect of higher returns isn't a panacea for poor retirement preparation or bad spending habits.
"People don't like to hear this, but you should have tempered future expectations and focus on the things you can control," said Robert Souza, CFA and relationship manager at Gamble Jones.
"What are you spending on? When are you planning on retiring? These are all moving pieces that can be altered," he said.