A Long Road Gets Longer

Story Highlights:

• A recent report from the CDC showed life expectancies for Americans grew once again.
• These increasing life expectancies continue to poke holes in age-based allocation models.
• Using your age as a marker to invest by is just too surface-level an analysis to hold much value.

While it’s true we’re all dead in the long term, a recent report from the Centers for Disease Control and Prevention (CDC) showed the period of time until then is getting longer for Americans. Among other things, the report showed an increase in the average American’s life expectancy to 78.2 years as of 2009. A 65-year old healthy man has approximately a 50% chance of living to age 85 and a 25% chance of living to 92! And for women, the odds are even higher of attaining the mid-90s. While these averages are only slightly higher than data from 2008, the long-term trend of rising life expectancies should call into question a commonplace tactic for financial planning—purely age-based asset allocation.

One common strategy for determining asset allocation is to take the nice round number of 100 and subtract the investor’s age. The remainder was supposedly the percentage allocated towards stocks. This might be an easy method to mathematically determine an allocation, but it ignores that medical science and life expectancies aren’t static. So what may have worked in providing enough growth to fund a retirement three or four decades ago could well now be a course for depletion prior to death. Today, longer retirements require a portfolio commensurate with that fact. And some age-based practitioners have admitted it by upping the baseline to 120. (We wonder what a planner upping the number would say to someone they’d previously consulted to use 100. Maybe, “Whoops, didn’t think about that medical science stuff”?)

But the real problem with age-based allocation alone isn’t the baseline number, it’s the approach altogether. Retirement is a significant marker in one’s life, but conventional wisdom has overemphasized retirement as a point to automatically make portfolio changes. That’s the way most folks—investors and professionals alike—have been trained to think. But consider this: A 60-year old retiree, living off his or her portfolio, needs to plan for it to last for life. Given that 78.2 is the average, with many folks living well beyond that point, prudent planning should be for a 20- or 30-year period (or more). A 30-year period is long, not short. And if one has a younger spouse, it’s his or her time horizon that should matter (unless you plan to cut them off at your death). On top of that, investors who have been saving and investing wisely over the years, may have accumulated wealth that can afford them better access to health care than the average person—who again, lives to nearly 80. So while retirement is clearly an important step, it’s only one step along a very long road.

But the problems with age-only allocation don’t stop there. These models assume everyone of the same age should have a cookie-cutter allocation driven solely by their biological timetable. But wait! Suppose you’re 75 with a 60-year old wife but don’t need a cent of your investments or maybe have very modest cash flow needs and your goal is to build an inheritance? Should you really have the same allocation as a 75-year old widow with significant cash flow needs just because you were born the same year? Thus, not only is a simple take-your-age-and-subtract-it-from-this-nice-round-number approach flawed due to increased life expectancy, it may not speak to an individual’s goals, return objectives, or other needs whatsoever—an entirely surface-level analysis.

Many studies have shown asset allocation to be the most important factor in determining long-term portfolio return—and hence, whether investors successfully reach their goals. What the CDC’s report shows is that more thought needs to go into planning for these increasingly longer retirements than the age-based-only model’s elementary school mathematics.