Retirement Risk, Rising Equity Glidepaths, and Valuation-Based Asset Allocation

Abstract

This research investigates two types of dynamic asset allocation strategies (predetermined equity glidepaths and valuation-based asset allocation) for retirees using U.S. historical data. We analyze fixed asset allocations, traditional declining equity glidepaths, rising equity glidepaths, accelerated traditional and rising glidepaths, valuation-based allocations tethered around a fixed allocation, and glidepaths with valuation-based overlays. With U.S. historical data, it is difficult to beat a strategy which maintains a consistently high allocation to stocks (especially as measured by terminal median wealth), to the extent that a retiree’s risk tolerance allows for this, and subject to the caveat that high stock allocations cannot always be expected to do as well in the future. However, when we consider retirements beginning in varying valuation environments (as defined by the level of Robert Shiller’s cyclically-adjusted price-earnings ratio relative to its then-current historical median), we find the potential for different dynamic allocation strategies to help retirees sustain higher spending levels with lower average stock allocations in certain situations. When retirements begin in overvalued market environments (which reflects the situation for new retirees today), an accelerated rising equity glidepath has shown much potential to provide downside risk protection for retirees by minimizing equity exposure when an adverse market event would have the greatest impact. In other valuation environments, historical worst-case scenario sustainable withdrawal rates were highest with valuation-based asset allocation strategies, which maintain a midrange average stock allocation but adjust higher or lower when markets are deemed undervalued or overvalued, respectively.