The Aggressive Allocation for a Near-Retiree
Your client, Robert, is 63 and plans to retire in 2 years. He has $800,000 in his 401(k) and $200,000 in a taxable brokerage account. His current allocation is 80% stocks and 20% bonds. He states that he wants to maximize growth because he is worried about outliving his money. He has a pension that covers 60% of his living expenses, and Social Security covers another 20%. He has no emergency fund. He mentions that his father lived to 95. Robert's risk tolerance questionnaire indicates a high tolerance for risk, but his financial situation suggests he may need to be more conservative. He asks you to increase his stock allocation to 90%.
1. What factors should you consider in evaluating Robert's request to increase his stock allocation to 90%?
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You must balance Robert's risk tolerance with his financial needs and constraints:
- Time horizon: Robert is 2 years from retirement. A 90% stock allocation is very aggressive for someone who will need to withdraw funds soon. A market downturn could significantly reduce his portfolio.
- Income sources: Pension covers 60% and Social Security 20% of expenses, leaving a 20% gap. His portfolio needs to cover that gap and any unexpected expenses. A 90% stock allocation increases volatility, which could jeopardize his ability to cover the gap if markets fall.
- Emergency fund: He has no emergency fund. A market decline could force him to sell stocks at a loss.
- Longevity: His father lived to 95, so Robert may have a long retirement (30+ years). Some growth is needed, but not necessarily 90% stocks.
- Risk tolerance vs. capacity: His questionnaire says high tolerance, but his capacity for risk may be lower due to near-retirement and lack of emergency fund.
- Behavioral biases: He may be overly focused on outliving money and not sufficiently on short-term risk.
You should discuss these factors and recommend a more balanced allocation, perhaps 60/40 or 50/50, and establish an emergency fund.
2. How would you respond to Robert's request, and what steps would you take?
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You should not simply comply with Robert's request without thorough discussion. Steps:
- Educate Robert on the risks of a 90% stock allocation near retirement, including sequence-of-returns risk and the potential for significant losses.
- Review his goals and constraints: Emphasize the need for liquidity and stability. Suggest building an emergency fund of 6-12 months of expenses.
- Propose an alternative allocation that balances growth with risk, such as 60/40 or 50/50, and explain how it aligns with his need to cover the income gap and longevity.
- Document the conversation and Robert's decision. If he insists on 90%, you may need to follow his instructions if he is mentally competent and understands the risks, but as a fiduciary, you should strongly advise against it. You might require a signed acknowledgment of the risks.
- Consider a bucket strategy: Set aside 2-3 years of expenses in cash/short-term bonds to avoid selling stocks in a downturn, allowing the rest to be invested more aggressively.
Ultimately, you must act in his best interest, which may mean refusing to implement a 90% allocation if it is clearly unsuitable.