In a previous column ("Face the new retirement reality," Feb. 17), we discussed the 21st-century version of retirement and how it will likely include part-time work or flexible working arrangements, in addition to income from Social Security and retirement plans (for those who have them).
Most people are financially unprepared to stop working completely. According to the Federal Reserve's Survey of Consumer Finances, only 51.7% of families headed by a person 65 or older have a retirement account. The median value of the retirement account among those surveyed was $80,700.
Not only do the economics of retiring dictate that most of us plan to work even after we qualify for Social Security, so does the biology and sociology of retiring — people are living longer and healthier lives. Many people continue to enjoy the positive benefits of working even when they've reached the Social Security system's full retirement age.
With these changes as a backdrop, it becomes clear that retirement conversations need to move beyond topics such as Social Security's antiquated concept of full retirement age. When we consider the impact of working on the asset allocation pie, it is obvious that advisers need to incorporate any earned-income stream into retirement planning. Employment-generated income, combined with income from Social Security, can count toward the fixed-income allocation for retirement. By continuing to work in retirement, investors can take on more equity exposure within their financial portfolio.
Twenty-first-century retirement, which includes income generation from some level of employment, requires a new asset allocation model.
We suggest an emphasis on actively managed investment strategies, particularly those that are benchmark-free. This is also an argument for investing with a fixed-income manager who isn't constrained to hugging a benchmark, kind of a "fixed-income-plus option."
Since people who choose to work in retirement can effectively use their employment income to offset some of what would typically be allocated to fixed-income securities, they can likely afford to hold more equities in their 21st-century-style retirement than the conventional retirement asset allocation would dictate. The extent to which they can allot more to equity exposure depends on the amount of income they generate from working and the predictability of that income. When you add the present value of Social Security income with the present value of work income, you can get a good estimate of the dollar amount of fixed-income allocation that can be displaced in a retirement plan.
In last century's version of retirement, a spending account, typically in the form of a money market account, is a needed source of funding for immediate expenses. For someone with other sources of income — for example, a job in which a periodic paycheck is the source of immediate and near-term funding — the cash slice of the asset allocation pie can get slimmer.
FILL THE BUCKET
The source of income is the analog to the retiree's spending account. For example, if you can rely on a semimonthly paycheck, that dollar amount can offset or reduce the amount you need in a spending account. Social Security and work income can fill up the bucket you would typically dip into the financial asset well.
An investor with a job will also likely want some cash holdings to account for any possible job loss, but that should be seen as a type of insurance rather than part of an investment strategy. Thus retirees who are also working may require a smaller cash allocation than the typical retirement asset allocation would suggest.
The new 21st-century retirement, in which people live longer and stay at least partially attached to the labor force, can transform today's view of asset allocation in retirement. Instead of the old notion of an increasing allocation to fixed income to provide stability and income, employment income can serve as a substitute. Predictable income also can lower cash demands for retirees. Thus the asset allocation of the new retiree should likely have a lower exposure to cash and fixed income than traditional models would suggest. Financial advisers looking to stay relevant in the 21st century must rethink asset allocation for 21st-century retirees.
Brian Jacobsen is chief portfolio strategist at Wells Fargo Funds Management. Wayne Badorf is head of intermediary sales at Wells Fargo Asset Management and president of Wells Fargo Funds Distributor.