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Why Asset Allocation Doesnt Matter Very Much
A helpful reader sent me a WSJ article with the provocative theme that all this investment advice about asset allocation
doesnt matter for most people. Why?
For the vast majority of savers, improved investment returns wont materially extend how long retirement money
lasts. Thats, in large part, because few investors have enough money in their retirement account to tilt the
balance.
Far more important, says the paper from the Center for Retirement Research at Boston College, are three
variables that dont require a brokerage account: how long you work, controlling spending and tapping the value
of your home.
Briefly, the study found that 47% of households would fall short of their income needs in retirement at age 67, when Social
Security kicks in for those born after 1960. However, even if investors were able to theoretically earn a guaranteed 6.5%
above inflation annually in a riskless investment, 44% would still be short.
How little are people saving? The WSJ article notes that having $500,000 in financial assets by retirement age would put in
you in the top 10% of savers. The CRR working paper itself mentions that the typical 401(k)/IRA balance of households
approaching retirement is less than $100,000 but I didnt see a source.
The Employee Benefit Research Institute (EBRI) found that in 2010 the average IRA individual balance (all accounts from
the same person combined) was $91,864, while the median balance was $25,296. EBRI also found that at year-end 2010, the
average 401(k) account balance was $60,329 and the median account balance was $17,686. But thats for all folks, not just
people of retirement age.
This shouldnt be too surprising. Your savings rate is the most important factor in determining if you can retire
comfortably. Working longer is the same as saving more and spending less (for a while). Getting used to spending less now
would aallows you to need less in retirement. Doing a reverse mortgage is just another word for cashing in your savings, isnt
it?
Why asset allocation is still important. The paper concludes that financial advisors should focus more on savings rates and
less about the complex ETF portfolio they just designed for you. Probably true. However, asset allocation has always been
something that we did to help our situation without actually doing the hard work of having to save more. Imagine a pill that
we could take to lose weight, while not actually eating less or exercising more.
I suppose we should view designing an asset allocation more as a potential boost to our nest egg than the driving force, and
realize that earning an extra 1% or 2% a year wont help if youre just compounding a small chunk of your income. How
much is enough? Studies have found that a savings rate of 16.62% would have worked out well historically.
Find more in Frugal Living, Investing, Retirement | 5/31/12, 3:04am | Trackback | Edit this entry
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Comments
1. Baughman Says:
May 31st, 2012 at 5:44 am e
Good article. I echo that most important predictor of retirement success is the ratio of income spent / income earned. It
seems that too many of us are focused on the income/savings side of things. Its far easier to learn how to live on 30%
less than you currently spend than it is to increase your savings from 500k to 800k. The irony is that you can live just as
well on 30% less if you develop appropriate habits. Trade in your ski boat for a pair of tandem kayaks. Trade in your
motorcycle for a bicycle. Trade in your trip to Europe for a backpacking adventure at your closest national park. Trade
in your $200/month cable subscription for a $3/year in late fees at the library. None of these changes diminish quality
of life in any way; in fact, they augment it while obliterating poor spending habits.
Its about time that our society leverages manufacturing and technological progress to enjoy a higher quality of life and
to stop buying ever and ever shinier trinkets, and working 80 hrs/week to do so.
2. Alexandria Says:
May 31st, 2012 at 5:56 am e
VERY true.
I think my family has the *saver gene.* There are several relatives in my family who never made big wages and never
put a penny in the stock market (kept it all in cash). & a lot of them are millionaires. & even the ones who took more
risks and are multi-millionaires were always heavy in cash. Their savings rate was always quite obviously their biggest
edge. Throw in a few good investments/luck and the results are mind-blowing.
Of course, some of the savers in my family were extreme, but my parents always were very well balanced. I agree with
Baughman. I dont equate saving with deprivation in the least. But we are very efficient, dont waste money on fees
and things that dont matter to us, and therefore have much more to save. one can save 30% of their income while
living very well.
3. Andy Says:
May 31st, 2012 at 6:35 am e
Most of the literature on the importance of asset allocation was originally developed for institutional portfolios where
the presumption was that the level of funding was appropriate to the level of liabilities and therefore the problem to be
solved was to quantify the trade-off between risk and return in optimal portfolios. Individuals naturally adopted the
conclusions drawn in that research. But I agree that it doesnt matter whether you have an efficient portfolio if you are
woefully under-saving for retirement. But I would argue that most of the individuals who are engaged enough to
implement some of this portfolio management theory are in the group that has a relatively well-funded retirement
portfolio because they tend to be focused on retirement, potentially higher-educated, and/or higher earning individuals.
6/2/12 Why Asset Allocation Doesnt Matter Very Much My Money Blog
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I really doubt that many of those who have only saved $10k towards their retirement by middle age are spending a lot
of time reading up on asset allocation theory.
4. Jon M Says:
May 31st, 2012 at 7:01 am e
One can save 30% of their income while living very well. Ha! Millions of families in the US barely have the ability
to pay their bills much less have anything left over to save. Millions more think that their automatic 5% into their 401k
will be enough to retire on. Millions more dont even know enough or care enough to put anything away at all!
The retirement of these people will have to be paid for somehow. With the pattern of the responsible people insuring
the failures of the reckless that has been showing up as of late, I fear that we 10% of savers will be footing the bill in
some way or another!
5. Baughman Says:
May 31st, 2012 at 7:08 am e
I should have clarified, the best predictor of retirement success is the ratio of current expenditures to current net worth.
6. Kurt @ Money Counselor Says:
May 31st, 2012 at 9:12 am e
I think if your savings are very small then nothing much matters, not just asset allocation, right?
7. whytax Says:
May 31st, 2012 at 11:58 am e
Thanks for the nice summary.
Is higher earning more important than asset allocation? Yes, I will work harder and get a higher paying job.
Is higher savings more important than asset allocation? Yes, I will find ways to live on less without compromising
quality of life.
Is asset allocation important? Yes, way better than keeping all my earnings in cash only to see it loose value with
inflation. I will continue to keep at my simple, low cost, diversified portfolio.
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