How A 60/40 Asset Allocation Can Change To 20/80 In Retirement

Pre-retirees and retirees may be understandably concerned about their exposure to stock market risk, particularly in these uncertain times.

Let’s take a look at how a hypothetical 65-year-old couple might think about this decision. Suppose Jack and Mary have $400,000 in retirement savings and they’re invested in a target date fund with the classic “60/40” asset allocation—60% invested in stocks and 40% devoted to bonds. Does a 60/40 asset allocation contain too much risk for them?

Their conclusion might be “yes” if they only look at the dollar amount of their retirement savings when making asset allocation decisions. However, they might think differently about it by reviewing the total amount of all their retirement income. Then, instead of making “asset allocation decisions,” they could make “retirement income allocation decisions.”

An example of the retirement income allocation decision

Suppose that between the two of them, Jack and Mary can expect to receive $37,836 per year in Social Security benefits at age 65. 

Let’s also suppose that when calculating how much to withdraw from their retirement savings to supplement their Social Security, they use the methodology of the IRS required minimum distribution (RMD). Even though the RMD isn’t required until age 72, the same methodology is a feasible retirement income strategy no matter when they retire. Using the RMD method, Jack and Mary’s withdrawal percentage at age 65 is 2.9499%, resulting in a withdrawal amount of $11,800 in the first year of their retirement.

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Now let’s look at their retirement income allocation. When adding their Social Security income to their annual withdrawal from savings, Jack and Mary’s total annual retirement income is $49,636. Of that total, 76% represents Social Security income, which doesn’t decrease if the stock market crashes and which also increases for inflation each year. 

The portion of their retirement income that’s subject to investment and inflation risk is the $11,800 amount. However, just 60% of this amount is supported by stock investments, with the remainder supported by bonds. Multiplying $11,800 by 60% results in $7,060 of their retirement income that’s subject to stock market risk each year. This amount is only 14% of their total retirement income. 

As a result, their retirement income allocation is 14/86, a much different allocation percentage than their 60/40 asset allocation.

What if they use the 4% withdrawal guideline?

If Jack and Mary use a less conservative drawdown strategy than RMD, their retirement income allocation will be different. So, let’s suppose they use the 4% rule to determine how much to withdraw from their retirement savings. Applying 4% to $400,000 results in an annual withdrawal amount of $16,000 from their savings in the first year of their retirement. Only 60% of this amount is subject to stock market risk, or $9,600. This amount represents 19% of their total retirement income.

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In this case, their retirement income allocation is 19/81, which is still much lower than their 60/40 asset allocation.

This example illustrates that their retirement income allocation percentage depends on the method they use to generate retirement income from their savings, and the amount of retirement savings they have to deploy. Just to use round numbers, Jack and Mary’s retirement income allocation could drop to 20/80 or less, depending on their decisions and circumstances. The retirement income allocation percentage paints a much different picture than asset allocation percentage.

By looking at their retirement income allocation to take into account all of their retirement income, Jack and Mary can make more informed investing decisions. And, as a result, they might feel more comfortable with the asset allocation of their target date fund.

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