Asset allocation when retirement is already secure

Question

A bit of background information, I currently have a pretty good defined pension plan with my employer, above average salary and ability to contribute to savings, high earning potential, and a low cost of living. I'm also a bit of a minimalist and am happy getting by on less.

In the past few years I've finally gotten rid of my debts and am getting closer to having real money to start building a portfolio. I've been researching investing for the past year and the general advice I get is that the younger you are the more higher risk investments you should include in your portfolio. (currently I'm 31)

The question I have here is what the rationale of doing this is if it looks like your nest-egg is already going to be sufficient in retirement and you're happy with the income that you're likely to have.

My inclination as I research is that I do not want to take any significant risks with the money I already have, but then I read rules like 100 - age to determine high risk products as a proportion of my portfolio, and wonder if there's something I'm missing, if it would be unwise at this stage of my life to create a portfolio that's too conservative.

To me it seems like a lot of the rationale behind investing is 'more money = good' and whatever means we have to accomplish this we should take. But what about defensive strategy where we want to essentially minimize losses? Is this something that might be a good idea, or am I throwing money away?

As a corollary, if anyone has recommendations on specific investment products based on this situation, that would also be appreciated.

Answer 1

he general advice I get is that the younger you are the more higher risk investments you should include in your portfolio.

I will be frank. This is a rule of thumb given out by many lay people and low-level financial advisors, but not by true experts in finance. It is little more than an old wive's tale and does not come from solid theory nor empirical work. Finance theory says the following: the riskiness of your portfolio should (inversely) correspond to your risk aversion. Period. It says nothing about your age.

Some people become more risk-averse as they get older, but not everyone. In fact, for many people it probably makes sense to increase the riskiness of their portfolio as they age because the uncertainty about both wealth (social security, the value of your house, the value of your human capital) and costs (how many kids you will have, the rate of inflation, where you will live) go down as you age so your overall level of risk falls over time without a corresponding mechanical increase in risk aversion.

In fact, if you start from the assumption that people's aversion is to not having enough money at retirement, you get the result that people should invest in relatively safe securities until the probability of not having enough to cover their minimum needs gets small, then they invest in highly risky securities with any money above this threshold.

This latter result sounds reasonable in your case. At this point it appears unlikely that you will be unable to meet your minimum needs--I'm assuming here that you are able to appreciate the warnings about underfunded pensions in other answers and still feel comfortable. With any money above and beyond what you consider to be prudent preparation for retirement, you should hold a risky (but still fully diversified) portfolio. Don't reduce the risk of that portion of your portfolio as you age unless you find your personal risk aversion increasing.

Answer 2

As others are saying, you want to be a bit wary of completely counting on a defined benefit pension plan to be fulfilling exactly the same promises during your retirement that it's making right now.

But, if in fact you've "won the game" (for lack of a better term) and are sure you have enough to live comfortably in retirement for whatever definition of "comfortably" you choose, there are basically two reasonable approaches:

1. You have no need to take risk, so don't. Invest in fairly low-risk things, though diversifying into a little bit of higher-risk stuff like equities probably makes some sense. Take the "safe" path and ensure you don't screw up a good thing.
2. You can afford to "gamble" with your money, so put it in riskier higher-yielding investments. If you do the math and even after losing, say, half your portfolio in a market downturn you'd still be alright, then you're probably fine as long as you have a diversified portfolio. This would give you the largest chance to generate "extra" money that you could give to charity or heirs or whatever, if that's a goal for you.
3. Yeah, I said two approaches, but the third choice is to do a combination of those first two. Do a "Liability Matching Portfolio" strategy, where you have the minimum you need for each year of retirement invested in something really low-risk like TIPS, and then anything in excess of that you invest as aggressively as you possibly can. See "Retire Worry-Free with TIPs as a foundation" by member "grok87" on the Bogleheads message board for some more information by somebody presenting it as a strategy.

Those are all reasonable approaches, and so it really comes down to what your risk tolerance is (a.k.a. "Can I sleep comfortably at night without staying up worrying about my portfolio?"), what your goals for your money are (Just taking care of yourself? Trying to "leave a legacy" via charity or heirs or the like? Wanting a "dream" retirement traveling the world if possible but content to stay home if it's not?), and how confident you are in being able to calculate your "needs" in retirement and what your assets will truly be by then.

You ask "if it would be unwise at this stage of my life to create a portfolio that's too conservative", but of course if it's "too conservative" then it would have been unwise. But I don't think it's unwise, at any stage of life, to create a portfolio that's "conservative enough". Only take risks if you have the need, ability, and willingness to do so.

Answer 3

You will hear a lot about diversifying your portfolio, which typically means having a good mix of investment types, areas of investments, etc. I'd like to suggest that you should also diversify your sources. Sad to say but the defined benefit pension is not a rock solid, sure fire source of security in your retirement planning. Companies go bankrupt, government agencies are reorganized, and those hitherto-untouchable assets are destroyed overnight.

So, treat your new investment strategy as if you were starting over, and invest accordingly, for example, aggressively for a few years, then progressively safer as you get older. There are other strategies too, depending on factors like your taste for risk: you might prefer to be conservative until you reach some safety threshold to reach "certain safety" and then start making riskier investments. You may also consider different investment vehicles and techniques such as index funds, dollar cost averaging, and so on.